Q2 2022 Brightspire Capital Inc Earnings Call
Greetings, ladies pensions and welcome to Bronx capital second quarter 2022 in his conference call.
At this time, all participants are in listen only mode.
The question answer session will follow the formal presentation.
If anyone should your client range assistance during the conference.
It's Tom do you separately on your telephone keypad.
As a reminder, this conference is being recorded.
I'd like to turn the conference over to your host Mr. David kind of my General Counsel.
Good morning, and welcome to the bright spire capital second quarter 2022 earnings conference call.
We'll refer to bright spire capital as bright spire, the RSP or the company throughout this call.
Speaking on the call today are the company's Chief Executive Officer, Mike Madden, President and Chief Operating Officer, Andy Witt, and Chief Financial Officer, Frank <unk>.
Before I hand, the call over please note that on this call certain information presented contains forward looking statements.
These statements are based on management's current expectations and are subject to risks uncertainties and assumptions.
Potential risks and uncertainties could cause the company's business and financial results to differ materially for a discussion of risks that could affect results. Please see the risk factors section of our most recent 10-Q and other risk factors and forward looking statements in the company's current and periodic reports filed with the SEC.
From time to time.
All information discussed on this call is as of today August 3rd 2022, and the company does not intend and undertakes no duty to update for future events or circumstances.
In addition, certain financial information presented on this call represents non-GAAP financial measures the company's earnings release and supplemental presentation, which was released this morning and is available on the Companys website present reconciliations to the appropriate GAAP measures and an explanation of why the company.
Believes such non-GAAP financial measures are useful to investors.
And before I turn the call over to Mike I will provide a brief recap on our results. The company reported second quarter 2022 GAAP net income attributable to common stockholders of $34.3 million or 26 cents per share.
And distributable earnings and adjusted distributable earnings of $31.4 million or 24 cents per share to.
The company also reported GAAP net book value of $11.26 per share.
Unappreciated book value of $12 42 per share as of June 32022.
With that I would now like to turn the call over to Mike.
Thank you David.
Welcome to our second quarter earnings call and thank you for joining us today.
Given the exceptional market volatility in this past quarter I will focus my comments on market conditions as a segue into Andy's comments on capital deployment and portfolio activity.
Finally, our CFO , Frank Saracino to discuss our second quarter financial performance.
Starting first with the headline we had another quarter of earnings growth distributable earnings increased from 22 cents per share in Q1 24 cents per share in Q2 more than fully covering the quarterly dividend of <unk> 20 cents a share.
The lending strategy that bright spire has undertaken since emerging from the pandemic was designed for challenging market conditions.
Our portfolio is more diversified than ever before with an average loan size down from $50 million in 2000, and $20 billion to $35 billion today.
Over that same period, our multifamily segment has grown from 30% to 52% of our loan portfolio and 80% of all new loan originations had been acquisition financing.
Our middle market lending program targets higher population growth regions drive to work markets and value add asset level strategies.
This portfolio strategy was designed to reduce large long risk concentrations with a focus on assets. It was underwritten NOI growth projections should outperform these rate increases.
Our previous two earnings calls I, specifically referenced record levels of inflation and the federal reserve's, well advertised plans to increase interest rates.
Rather than rehashing macro events of the last quarter, well simply state that it is abundantly clear that these market dynamics have begun to permeate the economy.
The capital market's reaction has been to shift into risk off mode brought on by these sharp interest rate increases.
Just recently the treasury yield curve inverted towards widespread in 20 years, while credit spreads continued to widen.
Overall market sentiment has become extremely bearish and this was validated with last week's report, indicating G. D. P declined again during the second quarter.
With two quarters in a row of GDP contraction, we have technically entered into a recession, although its ultimate length and depth remains uncertain.
If the current strong employment numbers can hold up well make any downturn more shallow.
Separately, there also seems to be a disconnect between public equity markets and the treasury and credit bond markets.
Equities are rallying a recession news, while 10 year treasury rates have moved lower and credit spreads have widened.
Based on history, we think the bond markets have it right.
Turning now to commercial real estate lending.
The market volatility along with higher cost of capital in both benchmark indices and credit spreads caused commercial real estate investment sales in lending activity to meaningfully contract during the second quarter.
Accordingly, it priced spire, our origination volume has been trending lower.
Is not just lenders being more cautious.
As I mentioned on the last earnings call.
First information feedback loop from lenders to mortgage bankers back to borrowers and asset sellers has worked to substantially shrank transaction sales and refinancing pipelines. Therefore.
Therefore, the demand for commercial real estate credit it's contracted.
C N B S. In CLO mortgage loan securitization volume, that's followed suit and declined in June and July while CLO spreads have widened further during the quarter.
Given these market conditions, we will be delaying the issuance of our third CLO in the near term and well reassess the market in the next few months.
We concur with others that the dearth of new issuance, along with AAA CLO is already yielding over 5% should lead to spread tightening in the coming months.
It makes sense that these market dynamics would also result in a slowdown in existing loan pay offs.
Which we are in fact seeing in our own portfolio.
Borrowers who have engaged in selling properties have suspended the marketing process in favor of maintaining their existing financing, while continuing to execute on their asset level business plants.
All of our loans have built an extension option subject to meeting certain criteria.
In the meantime, with interest rates and replacement costs, both higher construction development and single family home sales should continue to slow.
We therefore expect that multifamily occupancy rates will continue to benefit from both sides of supply and demand.
As a result of these risk off market conditions bright spire has shifted its focus with an eye toward maintaining higher levels of cash liquidity.
Well, we will continue to selectively quoting new loans actionable lending opportunities have become increasingly scarce.
This will continue to be the case until lenders and property owners see signs of market and valuation stability.
This will require a meaningful indications of downward inflationary trends along with more visibility as to the length and extent of the fed's rate increases.
Until that visibility occurs maintaining higher levels of cash liquidity is prudent.
This is a time to closely monitor our balance sheet and stay, especially close to our borrowers and banking counterparties with that I would now like to turn the call over to our president Andy wet Andy.
Andy.
Thank you, Mike and good morning, everyone after averaging nearly $500 million new originations in each of the five previous quarters.
Capital deployment.
As a result themes Mike highlighted.
During the second quarter the company closed on $306 million in aggregate loan commitments across nine newly originated loans with an initial funding of $279 million. All of these investments are floating rate first mortgages on cash flowing assets during.
During the month of June we did not close any loans. However, subsequent to quarter end we have.
Those three loans for a total commitment of about $91 million.
The second quarter, our loan portfolio grew slightly and currently stands at $3 8 million and total assets of $5 3 billion.
As highlighted last quarter.
Number of loans quoted has declined as a result, we are committing to fewer loans as expected our pipeline of actionable opportunities has declined as market participants adjust to the new normal most notably higher interest rates and the associated implications.
Anticipating a slow Q3 in terms of new originations as we're quoting new loans on a highly selective basis.
Counterbalancing the decline in new origination has been a slowdown in loan repayments during the second quarter, we received $248 million in repayments across eight loans and one partial pay down given.
Given the macro economic environment, we now anticipate loan repayments for the remainder of the year to be approximately $200 million per quarter significantly less than the four to 500 million we anticipated at the start of the year.
Staying ahead of prepayments and deploying capital on a net basis was.
What is the focus going into 2022.
At this point, we feel it more prudent to temporarily shift our stated business plan of deploying company liquidity, which currently stands at $438 million in favor of maintaining higher levels of cash on the balance sheet. We.
We believe this best positions the company to take advantage of future opportunities in the meantime, our earnings continue to benefit from the tailwind associated with rising silver as earnings are positively correlated with increasing interest rates.
The composition of our portfolio in terms of segment weightings remains relatively constant with the previous quarter.
The second quarter, there were a number of notable events within the loan portfolio, including the disposition of an equity kicker the partial pay down of our pre development landmark.
The increase in our seasonal reserve.
In the beginning of the second quarter, we executed on the sale of an equity kicker or related to a portfolio of industrial assets previously sold in 2019 generating a $22 million gain on sale.
The company also received a substantial pay down $51 million on a risk weighted or investment at all.
Also reduced our exposure to pre development.
The remaining balance for this loan is 57 million with a net exposure of $30 million.
<unk> will elaborate on the increase in our system.
As of June 32022, excluding cash and net assets on the balance sheet. The loan portfolio was comprised of 110 investments with an aggregate gross book value of $3 8 billion and the net book value of 946 million or <unk> 82.
2% of the portfolio.
The average loan size was $35 million and our risk rating 3.1.
Changed from last quarter.
First mortgage loans now constitute 97% of our loan portfolio of which 100% are floating rate.
Multifamily loans represent 52% and office and industrial combined comprised 33% loan portfolio.
3% of the collateral is located in markets that are growing at or above the national average growth rate.
We continue to manage the liability side of our balance sheet through a combination of financing sources, which include warehouse facilities across five primary banking relationships totaling two quake two 5 billion during.
During the quarter the company Upsized two of its warehouse facilities by $200 million in total.
Today availability under our warehouse line stands at approximately $712 million, which represents a 68% aggregate utilization.
Additionally, we have two outstanding CLO totaling $1 7 billion.
At present, 43%.
Percent of our loan collateral has been contributed to <unk>, 54%.
<unk> is on our warehouse lines and 3% is unencumbered.
Our 2019 CLO has a total collateral balance of $867 million the reinvestment window for the CLO is expire and as such each loan payoff will result in a reduction of the advance rate and an increase in the cost of funds, we anticipate philosophy.
CLO at some point over the next 12 months.
All of which will be dictated by the loan payoff velocity and market conditions.
As for the CLO, we issued in 2021.
We continue to actively manage reinvestments.
In summary, the company had a productive second quarter modestly growing our portfolio.
And increasing recurring earnings our near term focus has pivoted from net deployment to now maintaining higher levels of liquidity given the macroeconomic backdrop.
Now I will turn the call over to our Chief Financial Officer, Frank Sparacino to elaborate on the second quarter results.
Thank you Andy and good morning, everyone.
I would like to draw your attention to our supplemental financial report, which is available in the shareholder section of our website.
The supplement continues to provide asset by asset details as has our Form 10-Q.
For the second quarter, our distributable earnings and adjusted distributable earnings were <unk> $31.4 million or 24 cents per share.
Additionally for the second quarter, we reported total company GAAP net income attributable to common stockholders of $34 3 million or <unk> 26 cents per share GAAP net income includes the $22 million gain Andy referenced earlier and it's there for higher than distributable earnings and adjusted distributable earnings.
Which excludes this gain.
Company's second quarter GAAP net book value of $11.26 per share remained unchanged from the prior quarter, while unappreciated book value increased by six cents.
To $12.42 from $12.36 per share the.
The increase is primarily driven by share repurchases and the asset sell previously highlighted partially offset by an increase in our seasonal reserves FX translation related to our Norway office net lease asset and our annual ordinary course employee share grants.
I would like to quickly bridge, the second quarter adjusted distributable earnings up 24 cents versus the 22 cents recorded in the first quarter.
The increase is primarily driven by the full quarter impact of willing to originated during one Kim and the increase in the benchmark rates. Additionally, during Q2, we received a nonrecurring prepayment fee related to a loan repayment.
Adjusting for this onetime item and heading into three Q, our adjusted distributable earnings quarterly run rate, it's closer to 23 per share.
As to the remainder of the year.
Rapid pace and level of deployment over the last 18 months combined with slower than expected with payments has us well positioned to maintain higher levels of cash while continuing to produce adjusted distributable earnings that supports the <unk> 20 per share quarterly dividend.
Furthermore, our earnings are now directly correlated to in place to embed them from rising interest rates.
We provide more data in our supplemental financial report, but an illustrative 150 basis point increase in the benchmark rates. The June 30th spot rates would add roughly <unk> 8 million to our annual earnings or about eight cents per share.
All else being equal this translates to an ROA increase in our loan book of approximately 110 basis points.
Worth, noting that one month into the second quarter base rates already increased by approximately 60 basis points.
Turning to our dividend given our adjusted distributable earnings performance for the second quarter, we declared a <unk> 20 per share versus a 19 cents in the first quarter. This implies a year to date payout of approximately 85%.
Moving to our balance sheet, our total at share underappreciated assets stood at approximately $5 3 billion as of June 32022.
Our debt to assets ratio was 66% and our debt to equity ratio was two two times at the end of the second quarter up from two one times as at the end of the first quarter.
This increase was primarily driven by new senior loan origination and share repurchase.
As for common stock repurchases during the quarter and as previously announced our board of directors authorized a $100 million stock repurchase program.
To date, we have repurchased approximately five 3 million shares totaling $44 million at a weighted average price of $8.31 per share.
This resulted in a 16 sets of unappreciated book value per share accretion.
The repurchase shares include $25 4 billion of O P units and $18 3 million shares in the RSP common stock.
L. P units were owned by a third party going back to the data formation.
In addition, our liquidity as of today stands at approximately $438 million between cash on hand, and availability under our bank revolving credit facility.
At present, we believe our financing arrangements provide us with the liquidity and flexibility, we need to manage and grow our business for the foreseeable future.
Looking at risk rankings that see some reserves, we had neither any impairments or any nonaccrual loans during the quarter, one loan change risk ranking from a two or three due to our refinancing as all new loans. Initially begin with three rank them altogether, our average loan portfolio risk ranking at the end of the second quarter was.
3.1, which is unchanged from <unk>.
And finally, our Cecil provision was $45 1 million, an increase of approximately $10 $2 million from the prior quarter. The higher seasonal reserve that was driven by the current macroeconomic outlook as well as newly originated loans.
That concludes our prepared remarks, and with that let's open the call for questions.
Operator.
Thank you very much time, ladies and gentlemen at this time, we will be conducting a question and answer session.
Answer Christian piece Chris.
One key pad.
The nation channel indicated an easy question care.
Me too.
She would like to remove yourself from the question queue.
All participants, making he's off GPT equipment.
May be needed to meet each pick up your handset before pressing just talking.
We have posted amendment poll for questions.
The first question comes from Eric Hagen of P. P I G.
Hey, Thanks, Good morning, guys hope you're well is there maybe a couple for me here is there a minimum level of liquidity do you expect to operate with based on the comments you made in your opening remarks, how should we think about the dividend and the expectation for stock repurchases in light of those comments.
And second.
When you talk about the loan size coming down what do you think is the advantage of that or like why is it a feature that investors should be drawn too, especially in this environment does it speak at all to the quality of the sponsor or the financing that you're able to achieve when you make that one thanks.
Hey, Eric how are you good morning, it's Mike.
Good morning, a question.
So let me let me handle the the loan side as far as it's always been.
Our focus to be in middle market and to be at loan sizes that kind of range from you know the twenties into sub 100 million dollar range and the reason for that is and based on the company's experience and based on our shareholder equity.
Now that we felt that more diversification.
This was a critical feature in risk management here, and so bringing that average loan size down and it was very barbell and as you know the company historically has taken some very large write downs on some very big loans. So in this case, we're really trying to.
Diversified loan balance so that no one loan can really have.
Big Big material effect on the company.
It also helps us when we do securitizations with our diversification of the portfolio and we realize that we're not in some of the large alone msas, but quite frankly, we prefer the drive to markets for office, where you're seeing higher occupancy rates of tenants you are seeing in areas of Dallas, where there are 65.
570% occupancy rates or tenants rates, but in places like New York City San Francisco.
You're seeing very low office occupancy rates and so we're we're we're concerned that youre in a bigger msas, you're going to do bigger loans and we think those msas right. Now are also more risky.
Especially for office assets.
With regards to the cash.
We just you know as a mortgage REIT you can't be all end all the time, because you're perpetually long credit. So we're monitoring the market and quite frankly, Eric.
A lot of our brother and I was sitting on a lot of cash and I Express it as dry powder, we're ready to move take advantage of a lot of opportunities, but right. Now there are as we said on the prepared remarks very few actionable opportunities. After 10, plus years of deferred giving us a put to them.
The site is now putting back to the market. So right now our pipelines at brokers have basically evaporated and the actionable opportunities are a more far few between so whether you were designing yourself to sit on cash or not you're sitting on cash the prepayments as Andy said in his prepared.
Paired remarks have been slowing so that's to our advantage and we don't have a targeted amount we kind of were looking around the corner and we're trying to see what things can happen and we're trying to prepare for them. I think this is a market that nobody has seen before we have nine trillion dollars sitting on the fed's balance sheet. No. One is talking about that we're in an interest rate environment and inflation.
The environment No. One has seen before we've had 40 years of a treasury market rally. So I think it's prudent to sell them on the amount of cash we don't have an amount targeted right now I think it's something in the 270 range. We always said that we were going to operate with $100 million of cash on the balance sheet to move assets around so we've got a 175.
$5 billion.
It's earning a 2% for the first time.
We've seen that number in many years and you know we could look at potentially deploying some of that cash AAA CLO have gotten incredibly cheap as I said in my prepared remarks, they're yielding 5% last quarter I thought there would be yielding four 5% by the third quarter and they were yielding 5% in the second quarter.
So that's something that we're watching and if theres a way to maybe deploy cash there and apply a modest amount of leverage like 50% you can get to a 7% yield on that so we're looking at the CLO market. We do think that the Joseph issuance. There was gonna caused spreads to come in so right now 275 million of cash.
We're sitting on we don't have a predetermined amount of money. The excess is about 175, and we will just continue to manage that over the next couple of quarters until we see.
This visibility and Theres actionable lending opportunities.
That's very helpful color I appreciate that if I could sneak in one more here on the 'twenty 'twenty. One CLO is there any room for reinvestment that you expect to manage their like as you supposedly delever again based on kind of what you talked about in the opening remarks is there a composition change to the leverage that we should anticipate too. Thanks.
No. There's no change in levers that you shouldn't you shouldn't be looking at we did not I did not address your question about the buyback I'm going to let Frank talk about what we did there and what our thinking around the buyback is.
So yeah, so just to to the buyback look I think as we reset Eric there's a just a bias around you know.
Cash right now and you know as we have clarity in the coming quarters. You know, we will look to be opportunistic as far as buying back our stock, but you know nothing.
Nothing nothing planned at the moment beyond kind of where we are and we had an opportunity to buyback units from one holder at a price and we took advantage of that so we didn't have to move the market. So we were able to get something done at good levels in may but as the market starts to get a little bit Crazy. In June you. You know you would've thought we would've stepped into buying more but we were.
Seeing other things happening in the market.
Enormous spread widening and things like that in a risk off.
And the market, where we felt that we should pause for a minute. So we can revisit and deploying cash Eric we can revisit the share buybacks when we get a little bit more visibility, we had a great window to buy back stock lower than we thought we could.
And we'll see where the market goes if the market improves stock price improves and we're going to risk on we'd much rather put the money out in loans.
Okay.
That's helpful color I appreciate it guys.
Thank you. The next question comes from Christopher <unk> of J.
J M P securities.
Hey, guys. Thanks for taking the question I'm on for Steve Today can you talk about how loan spreads on new loans have changed over the last six months and are you guys getting wider spreads on new loans compared to loans that are paying off.
Yes, the spreads have widened you're getting much wider spreads you're probably out to a four handle.
And spreads.
Multifamily and wider for for office and industrial.
Pending on the leverage point the banks our bank Counterparties have moved out they are looking at the CLO market. We all are.
And they've moved out probably a solid 100 basis points in terms of cost of funds with the banks. The banks are also becoming a little bit more.
Cautious as well some banks are actually out there are syndicating their their warehouse lines, but when you look at their work with quoting spreads today based on where we can execute with the banks and Clo's and get our required ROE returns effectively.
Borrowings between index spread and purchasing a rate cap borrowers are at like 7%.
And the world really doesn't work well at 7%. After we've had 10 years of.
A very dovish monetary policy, so I think as Andy said in his prepared remarks that we're all waiting for the new normal to take hold and figure out where that is and so being a 400 over Chris correct quite frankly, the amount of actionable lending at.
<unk> hundred over as is as far and few between where we could do something in one of my former colleagues. Brian Harris mentioned this I think on his call is that there may be room for stretch mortgage lending, where you're doing more than 75% 70, maybe 80% and you can get that into your spread as opposed to doing mezz in this market.
There is no room for Mezz, there's no room for additional cost of funds the cost of funds between index spread in cap has gone up so significantly that there's no home to add mass at 12%. So maybe there's room to do stretch mortgages, but is that as I said earlier the pipelines at the broker's, whether it's for.
Auction sales or refinancings. So those pipelines have really dwindle. So I think between now and September youre going to see very little and perhaps after labor day. Some of those those are <unk>.
Transactions will put up their periscopes and come to market, but right now I think it's going to be very slow for the next quarter.
Got it that's helpful. Thank you and then on your comments about the banks how are they reacting in terms of widening spreads versus just slowing lending overall from what you guys are saying.
Well widening spread is there a throttle on the action right. So by widening spreads basically expressing to us that they want to be more cautious and they're not jumping up and down saying Oh Gee, we can get stuff at 300 spreads you really kind of quoting those spreads to be more defensive.
And more selective you have a lot of banks, who have a warehouse.
<unk> said that we're expecting to be unwound in the Clo's and they've got a lot of SaaS positions that they're long that they were not able to execute on so the banks themselves are looking at their real estate positions and saying, there's probably some indigestion theyre and theyre expressing it to their.
Their borrowers like the commercial mortgage REIT by widening spreads. So it's not just a cost of fun thing. It's the banks the way of expressing themselves that they'd like to be more cautious and we'd like to slow it down.
Got it helpful. Thanks for taking the questions.
And Oh by the way when they when they look at AAA CLO as pricing of 275 over and they are advancing 80% cost of funds cost of funds in the CLO.
It was probably somewhere in the 325 range based on the last execution. So the banks see that for the entire stack.
The triple B minus.
That's the 330 level 15 level, so to be 80% on a whole loan it makes sense that the bank should be in the low three hundreds.
Got it appreciate the comments thanks guys.
Okay.
Thank you ladies and gentlemen, just a final reminder, if at all for Christian you want them to buy stock in one and he's kind of funky patch.
Two question. Thank you.
Yeah.
Ladies and gentlemen, it seems we have reached the end of question and answer session.
Yes.
And apologies we have a follow up question from Eric Hagen of P. T G I.
Yeah, Thanks, I thought I'd sneak in one more.
When a sponsor goes to extend their loan can you talk about any of the terms that may change when they explore doing that or whether there's any thresholds that they need to meet.
From an operational standpoint for them to extend their alone.
Yeah, we could answer that Andy want would you like to address that please.
Sure.
So typically what happens is when a borrower comes back for an extension there are certain covenants.
Covenants in the loan that they they have to cover and then as part of the extension we get.
A rate cap so that that's really the process and those are those.
Those levels are determined on a loan by loan basis based on the underlying business plan.
At the time of underwriting.
Okay.
Gotcha. That's helpful. Thanks for sneaking me in.
Thank you ladies and gentlemen, we have now reached the end of the question and answer session.
Ill turn the call back over to Mr. Mike Mears he looks at a few remarks.
Well. Thank you and we appreciate you attending today, we realize there were other competing earnings calls at the same time. So thank you for your attendance and we look forward to speaking to you again on our third quarter earnings call in November . Thank you.
Yeah.
Thank you.
Ladies and gentlemen that concludes today's conference. Thank you for your participation and you may now disconnect your lines.
You guys still on.
Yep Yep, we're still up.
[music].
Okay.
[music].
Okay.
[music].
Yeah.
Yes.
[music].