BrightSpire Capital - Q2 2023
August 2, 2023
Transcript
Operator (participant)
Greetings, and welcome to the BrightSpire Capital Inc. Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce to you David Palamé, with General Counsel. Thank you, David. You may begin.
David Palamé (General Counsel, Secretary and EVP)
Good morning, and welcome to BrightSpire Capital's Second Quarter 2023 Earnings Conference Call. We will refer to BrightSpire Capital as BrightSpire, BRSP, or the company throughout this call. Speaking on the call today are the company's Chief Executive Officer, Mike Mazzei, President and Chief Operating Officer, Andy Witt, and Chief Financial Officer, Frank Saraceno. Before I hand the call over, please note that on this call, certain information presented contains forward-looking statements. These statements, which are based on management's current expectations, 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 the results, please see the Risk Factors section of our most recent 10-K 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 2, 2023, 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 company's website, presents reconciliation to the appropriate GAAP measures and an explanation of why the company believes such non-GAAP financial measures are useful to investors. Before I turn the call over to Mike, I will provide a brief recap on our results. The company reported Second Quarter 2023 GAAP net loss attributable to common stockholders of $7.5 million, or $0.06 per share.
The company reported Second Quarter 2023 Distributable Earnings of $21.1 million or $0.16 per share, and Adjusted Distributable Earnings of $32.0 million or $0.25 per share. The company also reported GAAP net book value of $10.16 per share and undepreciated book value of $11.53 per share as of June 30, 2023. With that, I would now like to turn the call over to Mike.
Michael Mazzei (CEO)
Thank you, David. Welcome to our Second Quarter Earnings Call. Thank you for joining us this morning. As David mentioned, we are pleased to report Adjusted Distributable Earnings of $0.25 per share, while our dividend coverage continues to remain strong. Current liquidity as of today stands at $347 million, of which $182 million is unrestricted cash. During the quarter, we again reduced our overall leverage to 1.9x. This quarter, we recorded a $0.21 reduction in undepreciated book value, which currently stands at $11.53. This reduction was primarily driven by a net increase in our general CECL reserves, in addition to a specific reserve on one office loan, which was already on our watch list. Andy will provide more details in his section.
As everyone is well aware, throughout the first half of 2023, unprecedented market conditions have pressured commercial real estate borrowers across the board, regardless of property type. These strains are unlikely to ease until the Fed begins reducing short-term interest rates, which is now expected to occur sometime in 2024. With another interest rate hike just last week, the Fed is very near the end. Given the current strong economy, the Fed will maintain a higher for longer interest rate policy while continuing to reduce its balance sheet. This remains the primary risk factor for the commercial real estate markets over the next 12 months. Regarding our portfolio, the overall performance of our underlying office properties during the quarter has remained steady. We have in fact upgraded the risk ratings for 2 office loans and removed them from our watch list.
This is the result of these borrowers making significant progress in their leasing plans. Given the increased focus on this property segment and in an effort to provide investors more information, we have included in our Second Quarter Supplement Package a description of our five largest office loans, which represents 35% of our office loan portfolio. Multifamily, which represents 52% of the portfolio, has remained resilient. We have experienced top-line rent increases across the portfolio, which have exceeded our underwriting projections. However, all property types, including Multifamily, have not been immune from the rapid rise in inflation and corresponding interest rate increases. In some cases, the positive impact of higher rental rates is being muted by rising operating expenses such as utilities, payroll, and insurance. In some select instances, we have seen increases in bad debt, primarily due to legacy, tenant-friendly COVID policies in certain jurisdictions.
Ultimately, we expect these conditions will improve in the coming quarters as we work with these borrowers to execute their value-add business plans. In the meantime, this quarter, we have identified and downgraded three Multifamily loans from a three to a four to reflect specific circumstances at the property and/or the sponsor level. Importantly, all three of these loans, as well as the entire Multifamily book, are current in debt service payments. As we look at the second half of the year, our focus remains on managing our portfolio while maintaining sufficient liquidity and lower leverage. We are, of course, eager to get back on offense and make new investments, especially as we expect many regional banks to shrink their balance sheets in the coming year. Last week's merger of two West Coast banks is a great example of this.
This pullback by regional banks should create ample opportunities for private credit and non-bank lenders like BrightSpire. However, in the near term, protecting the balance sheet continues to remain job number one. With that, I would now like to turn the call over to our President, Andy Witt. Andy?
Andrew Witt (President and COO)
Thank you, Mike, and good morning, everyone. Throughout the second quarter, the BrightSpire team has remained focused on asset and portfolio management. We believe the combination of our vertically integrated and internally managed platform, including our rated special servicer, uniquely positions BrightSpire to navigate the current environment. None of our loan asset management functions are delegated to third parties. During the second quarter, we received $162 million in repayments across 2 investments in line with expectation. Included in the repayments for this quarter was the Berkeley Hotel loan for $148 million. Year-to-date, we have received approximately $263 million in loan repayments, and as previously highlighted, we expect loan repayment activity to remain relatively low for the remainder of this year.
Our second quarter supplement now includes additional information on all our risk-rated 4 and 5 loans or our watch list loans. Our watch list office loans were relatively consistent with what we reported to you in the first quarter. One office loan was added to our watch list this quarter. As Mike mentioned, two office loans were upgraded and removed from the watch list. During the second quarter, we executed deeds in lieu on two Long Island City loans in cooperation with our borrower and have taken full control of both office properties. We have engaged with a third-party property manager. Taking control of the properties has signaled to the market that ownership is now stable and well-capitalized. This has resulted in renewed leasing interest, and we have already received unsolicited inquiries from prospective tenants.
We believe the reset basis in these properties will allow us, as owner, to better compete for tenants and ultimately stabilize and exit the properties. In terms of updates on the Washington, DC, office loan, we anticipate taking control of the asset over the next few months, after which we anticipate commencing a marketing process for the property. During the second quarter, we placed the Oakland office loan on non-accrual, increased the risk rating from a four to a five, and recorded an $11 million specific CECL reserve. Additionally, subsequent to quarter end, we executed on a deed in lieu and have taken ownership of the property. Lastly, we continue to monitor the Oregon Office Park Senior Loan and have provided detailed disclosure on these investments and others in our MD&A, contained within the Q2 2023 Form 10-Q.
With respect to the San Jose hotel property, last quarter, we noted that a sales process was underway for the hotel annex tower, comprised of 264 rooms. During the quarter, a buyer was selected and terms have been agreed to. The borrower anticipates the sale and corresponding paydown of our loan to occur in the third quarter. The loan remains risk-rated 4. As of June 30, 2023, excluding cash and net assets on the balance sheet, the loan portfolio is comprised of 96 investments, with an aggregate carrying value of $3.2 billion and a net book value of $917 million, or 81% of the total investment portfolio. The average loan size is $33 million.
Our weighted average risk rating is 3.1, and the loan portfolio has minimal future funding obligations, which stand at $226 million, or 7% of outstanding commitments. First, mortgage loans constitute 97% of our loan portfolio, of which 100% are floating rate and all of which have interest rate caps. The multifamily portion of our portfolio consists of 56 loans, representing 52% of the loan portfolio or $1.7 billion of aggregate gross book value. Office comprises 32% of the loan portfolio, consisting of $1 billion of aggregate gross book value across 31 loans, with an average loan balance of $33 million. The remainder of our portfolio is comprised of 9% hospitality, with industrial and mixed use collateral making up the remainder.
With that, I will turn the call over to Frank Saracino, our Chief Financial Officer, to elaborate on the second quarter results. Frank?
Frank Saracino (CFO)
Thank you, Andy. Good morning, everyone. Before discussing our second quarter results, I want to mention that we expect to file our Form 10-Q later today. Our Second Quarter 2023 Supplemental Financial Report is also available on the investor relations section of our website. For the second quarter, we reported Adjusted Distributable Earnings of $32.0 million or $0.25 per share. second quarter distributable earnings was $21.1 million, or $0.16 per share. Distributable Earnings includes an $11 million specific reserve on one loan. Additionally, for the second quarter, we reported total company GAAP net loss attributable to common stockholders of $7.5 million, or $0.06 per share. The GAAP net loss reflects $29 million of total loan loss reserves, consisting of the $11 million specific reserve and $18 million of general loan reserves.
Quarter-over-quarter, total company GAAP net book value decreased from $10.41 per share to $10.16 per share. Undepreciated book value also decreased from $11.74 per share to $11.53 per share. The decline is primarily driven by increases in our CECL reserves, partly offset by Adjusted Distributable Earnings in excess of dividends declared. I would like to quickly bridge the second quarter Adjusted Distributable Earnings of $0.25 versus the $0.27 recorded in the first quarter. The change is driven by loan repayments, loans placed on non-accrual during the quarter, and lower one-time loan modification income, offset by the impact of rising interest rates. Heading into 3Q, our Adjusted Distributable Earnings quarterly run rate should remain around current levels. Turning to our dividend.
For the second quarter, we declared a dividend of $0.20 per share, in line with the first quarter. Our dividend remains well covered at 1.25x. Looking at reserves and risk ranking. As Andy mentioned in his comments, during the second quarter, we took ownership of the two Long Island City office properties and placed the Oakland office loan on non-accrual and recorded a specific reserve. This resulted in our second quarter specific CECL reserve decreasing by $57 million to $55 million. Our general CECL provision stands at $52 million, an increase of $18 million from the prior quarter. This increase in general CECL was primarily driven by economic conditions, as well as specific inputs on certain office and Multifamily properties.
The combination of asset-specific and general CECL reserves at second quarter end was $107.5 million, or 312 basis points on loan commitments. As a reminder, these are point-in-time assessments that we evaluate each quarter. Looking at changes in risk rankings during the quarter, our review resulted in 4 loans moving to our watch list, comprising 3 multifamily loans and 1 office loan. We upgraded 5 loans during the quarter to a risk ranking of 3 and removed them from our watch list. As Mike mentioned, 2 of them were office loans on properties located in San Francisco, California and Baltimore, Maryland. The other 3 upgrades included the Milpitas Mezz A, 1 hotel mezzanine loan, and a construction loan.
Altogether, our average loan portfolio risk ranking at the end of the second quarter was 3.1, compared to the first quarter's average of 3.2. Our 3 risk rank 5 loans represent approximately 1% of the total loan portfolio carrying value. 7 loans, equating to 14% of the total loan portfolio carrying value, are risk rank 4. While all risk rank 4 loans are current performing loans, we are seeing potential for increased risk and accordingly are closely monitoring these investments and working with sponsors to ensure the best possible outcomes. Moving to our balance sheet. Our total at-share undepreciated assets stood at approximately $4.5 billion as of June 30, 2023. Our corporate leverage levels remain at the low end of the sector.
Our debt-to-assets ratio is 63%, and our debt-to-equity ratio is 1.9x, down quarter-over-quarter. This concludes our prepared remarks, and with that, let's open it up for questions. Operator?
Operator (participant)
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you please limit yourself to one question and one follow-up. Thank you. One moment, please, while we poll for questions. The first question comes from the line of Sarah Barcomb with BTIG. Please proceed with your question.
Sarah Barcomb (VP and Equity Research Analyst)
Hi, everyone. Thanks for taking the question. I was hoping to, if you could speak to how you think about giving loan modifications and extensions to help sponsors get to the other side of this rate hike cycle, versus just removing those assets from the books, realizing a loss there, but getting some capital back now to allocate elsewhere. How do you think about that generally?
Michael Mazzei (CEO)
... Hey, Sarah, how are you? It's Mike. I'll, I'll start off with that, and I'll let Andy interject as well. I mean, generally, we have a bias toward working with all borrowers. Where we feel like there's equity to protect, borrowers should step up and, and do something to help cover shortfalls. That could be either some pay down of the loan, we've experienced that, buying the interest rate cap, which these days is, is expensive, and some of our borrowers have definitely stepped up to do that, as well as covering interest rate shortfalls and building up the reserves. Sometimes they ask us for lowering the hurdles for the extension.
The borrowers have a view, "Hey, if we're putting money into the deal today, we'd like to make sure that we're not-- we have an option of getting it out, and that you, you don't keep the hurdles for the next extension so high." Generally speaking, we have a bias toward working with our borrowers in this environment. In many cases, many cases, our borrowers have stepped up, have made capital calls to their LPs and have funded, and have funded some shortfalls there. Andy, any, any additional thoughts on that?
Andrew Witt (President and COO)
No, Mike, I, I think you covered it. Really, at the end of the day, we're looking for commitment from the sponsor or the borrower in the form of a financial commitment or operational commitment, and with that, we're generally able to figure out a path forward. So that's certainly path number 1. The alternative path is, as you outlined, Sarah, taking the asset back and subsequently addressing any issues with the asset and ultimately moving it off of our balance sheet.
Sarah Barcomb (VP and Equity Research Analyst)
Okay, I appreciate those comments. As a follow-up, I was hoping you could talk about the extent to which you used cash to buy loans out of CLOs during Q2, and were any of those loans watchlisted? Could you just generally talk about liquidity needs coming from BrightSpire on loans that you're looking to de-lever in the coming months, just given the expectations that you spoke to during the prepared remarks for lower repayments this year?
Michael Mazzei (CEO)
Okay, you know, on, on that question about buying out of the CLO, we have Matt Heslin with us, who runs our capital markets. Matt, why don't you give an update on what we did this quarter on the CLOs?
Matthew Wallach (COO)
Sure. Thanks. In Q2, we bought out two loans from our 2019 CLO. One of those was an exchange, the other one was a cash purchase. Total loan balance that was removed was about $98 million. Total cash that was used to purchase those two out was about $77 million.
Michael Mazzei (CEO)
The CLOs, even though we're past the reinvestment period, there are, there is criteria in the CLO where you can make a potential substitution for a loan. One of the loans that came out, we were able to to substitute another loan in, which helped the liquidity there. Going forward, Sarah, it's, it's managing that liquidity around any potential defaults in the CLO, we have to buy out a loan or any potential buyouts on warehouse lines that we're watching, we're watching very closely. I think we try to articulate that in our watch list policy. We have, and we've said this on earlier calls, I think I've addressed this question with you before.
The policy we have is we really want to avoid surprises, and that really is a loan going from a 3 to a 5 where it's non-accrual. So we have a bias toward moving loans into the watch list on a 4 basis. All the loans that we moved on to the watch list for this quarter are current loans, and we can work through those issues with those borrowers. Like the loans that were upgraded off of the watch list this quarter, we can see the same happen there. We have a bias toward putting the loans on the watch list so that if something does go awry, that investors and analysts such as yourself, have been given a heads-up.
Along those lines, you know, we, we think that, with the Oregon loan, which is a 4, we're in dialogue with that borrower right now, and I think that there is a decent shot that, that loan does, does move to a 5 in the next quarter. Then with regard to other loans that are on the watch list, as I said, the new loans that went on are all current and, glancing at it now, all the loans on in risk 4 are current loans. We are working very closely with the borrower on the San Jose hotel. That loan is current, in the disclosures in the MD&A this quarter, we described how the mezzanine was, there is a mezzanine class behind us.
That mezzanine class was upsized, by about $4 million to, to make future debt service payments as the hotel tries to reach stabilization. We mentioned in the prepared remarks, that despite the fact that a part of that hotel is under contract for sale, that could affect the credit positively. We're keeping it as a risk-weighted 4 until that transaction is consummated. We think that is a, a September or October, potential close. From what we understand, the, the owner may, may be in the market, inquiring about potential for the sale of the entire hotel. If that were to, to occur sometime in Q4 or early Q1, you could see the biggest loan on our watchlist 4 move. We're watching that very closely. The, the hotel is not yet stabilized.
We're very happy with the new flag in place. And that the mezzanine is protecting. That will be a big move for us in terms of liquidity, because that loan, as we've said on previous calls, is, I think, only levered about under 50%. I think it's like 47% leverage. We have a lot of liquidity tied up in that loan. A sale of that one tower and potentially the sale of the entire hotel would have a huge benefit for us, liquidity-wise.
Matthew Hallett (Equity Research Analyst)
Great. Thanks for all that detail.
Operator (participant)
The next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Hi, good morning. Appreciate all the details on each of these assets. Andy, I wanted to follow up on two that you mentioned. You know, first, on the Long Island City office, you know, you talked about the, the, you know, initial interest you're seeing now, now that, you guys are in control. Can you talk about a, you know, timeline there, kind of when you look to stabilize and, and sell the asset, you know, kind of what metrics are you looking to achieve for, for stabilization?
Michael Mazzei (CEO)
You know what?
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Thank you.
Michael Mazzei (CEO)
Let me, let me lead off with that. I'm going to lead off with that, Steve, because I'm very, I'm very proximate to that day-to-day.
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Great.
Michael Mazzei (CEO)
That, there's one building that Andy was mentioning, that we had leasing inquiry on. That was the Paragon building. That building is unique. I don't mean to say that our buildings are better than New York office buildings. We know what's going on in the office market. That building is unique because it sits right on top of a subway station and a rail station, and a block away from a major subway line. We've gotten a lot of inquiry on that. What we're finding is that, you know, when you do a short sale process, you're attracting low bids because they sense the buyers sense distress, and rightfully so. I don't begrudge them that.
We felt like taking these assets over to demonstrate that they're in stable hands, and more importantly, that leasing brokers are going to get paid, and that's the case. Now that we, we own these properties, we are getting inquiry in there. I think for an exit on that, we'd have to start to see some level of stabilization, some leasing activity, where if we have LOIs in place that are strong and we have maybe tenant improvement program for that tenant, up and running, where a buyer or prospective buyer can see that the property could at least, sustain its operating expenses, and the negative carry on that is less. I also think, we said this in the prepared remarks, this higher, higher for longer is affecting everything, this rate environment.
If you get to a point where the Fed is telegraphing lower rates, buyers can see a potential lower cost of capital. We get some leasing traction there, I think then we really want to move the asset. We don't want to hold an asset until it's fully occupied and stabilized. We'd really prefer to get the liquidity back. It'll be like a crossover point where we think we could get the maximum value for where the state of the asset is. We are very pleased that now that we own the asset and have a third-party manager in, that we are getting incoming phone calls. I do think it'll take, at least a couple of quarters or several quarters for that to sift its way through.
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Great. Similar on Oakland office loan, you know, with the deed in lieu in Q3, you know, is that one you'll look to sell quickly, or is that one that'll go through a similar process?
Michael Mazzei (CEO)
We hired a third-party manager. That asset is an older asset. We're very glad that it is a low-balance asset. That's, that's the silver lining on this. I don't have positive things to telegraph at this point in time, given that we just got control of the asset. I do think there needs to be some CapEx that goes into the asset, that the owner neglected doing, for obvious reasons, knowing that the asset was changing, changing hands. Nothing really to report on that at this point.
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Great. Lastly, any update on the Norway asset? Thanks.
Michael Mazzei (CEO)
No, no update there.
Stephen Laws (Head of Real Estate Finance and Fixed Income Capital Markets)
Great. Appreciate it.
Operator (participant)
The next one comes from Matthew Hallett, with B. Riley Securities. Please proceed with your question.
Matthew Hallett (Equity Research Analyst)
Hi, guys. Thanks for taking my question. First, I mean, congrats on continuing to delever and, you know, focus on liquidity. Just any update with the bank lending group and the dialogue, is it still cordial? Obviously, you have a lot of availability under it. Just any update on the dialogue with the banks?
Michael Mazzei (CEO)
Yeah, Matt, you want to address that?
Matthew Wallach (COO)
Yeah. I mean, obviously, we've been working with our banking partners for a number of years here. You know, dialogue is very positive. As, as Mike mentioned, you know, we've been working through some amendments which involve, you know, sponsors putting cash in and, and buying new caps. We obviously work very closely with our banking partners on all those changes, assuming those loans are on the repo lines. And they've been, you know, extremely supportive and in line, having a very similar view to what we have on those deals, where, you know, seeing sponsors contribute equity and really step up and support the assets allows us, you know, to continue to finance them and the banks to continue to finance us. We're very aligned, and conversations have been very positive to date.
Michael Mazzei (CEO)
Yeah, they've been very constructive.
Matthew Wallach (COO)
Appreciate it.
Michael Mazzei (CEO)
They've been very constructive and supportive, and I could probably-- that's probably the case with most of our peer group. As long as you're giving them total transparency, and they feel like you've got credibility with them, which is primary with us, we're getting that support from them.
Matthew Hallett (Equity Research Analyst)
... That's great to hear, and I know you've got a lot of availability in the lines, and it's great to hear that, you know, they're working with you guys on, on some of the, on the portfolio. Second question-
Michael Mazzei (CEO)
One thing about that, Matt, let me just add one thing about that.
Matthew Hallett (Equity Research Analyst)
Go ahead.
Michael Mazzei (CEO)
Is that, you know, when we, when we project liquidity, we, we talk about cash, and we really think-.
Matthew Hallett (Equity Research Analyst)
Right
Michael Mazzei (CEO)
that there needs to be a distinction between, and some of our peer group are doing a good job at making this, this, this, this characterization. There's a distinction between availability and your re-reinvestment on CLOs. Some, some of our peer groups state that they have liquidity because they have assets that are underlevered, but they have pre-approval to increase that leverage. We view that as liquidity. Just saying that we have capacity on our warehouse line, we have capacity for $800 million on our warehouse lines. We do not telegraph that as, as liquidity. We believe liquidity is cash on the balance sheet, in place, unused capacity on a revolver or untapped capacity on a warehouse line that's pre-approved. Right now, we do have capacity to lend.
We have $800 million of capacity in our warehouse lines that we'll tap with our available cash as the haircut, if we go on offense anytime soon.
Matthew Hallett (Equity Research Analyst)
Yeah, that's I'm glad you pointed out. I mean, you almost have you can almost double the line, and that's availability to do a lot of interesting things when you're ready to go on offense. It's great to hear. I figured I'd ask that question because they have been very supportive with you guys, and it's great to hear that they're standing by you. Second question, Mike, on the on the triple net lease property in Norway, any headway on, you know, Is it the state pension fund that's trying that you're trying to get to renew and eventually refinance that debt?
Michael Mazzei (CEO)
No, the status of that has not, has not changed. The tenant, which is the, the state oil company of Norway...
Matthew Hallett (Equity Research Analyst)
Right
Michael Mazzei (CEO)
has until 2030 on that lease. As we say in the disclosures, the debt matures in 2025. We have the lease payments hedged. We were able to put on a 3-year hedge when we did it, in 2021. That goes to May of 2024. Until we engage with that tenant to get a possible extension, the status quo has not changed.
Matthew Hallett (Equity Research Analyst)
Can I ask if you've approached them with maybe offering you know, if you extend early, you know, you give them a discount, and that way you get the debt refinance and maybe even sell the property? I mean, Is that the strategy that you're looking at?
Michael Mazzei (CEO)
I've been to Norway. We've had face-to-face meetings, and I would say all of the above were put on the table. They have the benefit of being the state oil company of Norway. They have a process that they go through, and we have to observe that process in terms of how they assess their real estate needs. We are in contact with them as frequently as we can be. We were told that they may have a decision in June. That's been postponed till September. We are waiting for that, and again, if they'll invite us to go to Norway, we'd be more than glad to go. All those options are on the table. Absolutely.
Matthew Hallett (Equity Research Analyst)
Great. Just last question. I mean, any green shoots? I mean, the rates are up obviously here again, today. Any green shoots in, in, you know, just the general CRE market and transactions? I mean, some of the REIT stocks have been rallying back up. I mean, not the headlines have been horrendous, but is it over? It could be overdone. I mean, any green shoots you're seeing, Mike? Thanks, thanks a lot.
Michael Mazzei (CEO)
Generally, I'd say we would, we would trade earnings on an EPS basis, that have been there because rates are up. We would trade that for better credit any day. We're looking forward to rates coming lower because we think, as I said in the prepared remarks, that's causing distress and is probably the number one risk factor across real estate, regardless of property type. Office has its own idiosyncratic issues that are big. I don't, I don't mean to understate them, but higher interest rates are affecting every asset class and credit, particularly office. The green shoots are, as I said in the prepared remarks, the retrenchment of the regional banks. There are over 100 regional banks and probably something like several thousand to 4,000 community banks out there.
I think we were all somewhat surprised to see the amount of commercial real estate being done there, because it's spread out so far among all these banks. It's very hard to detect unless you're an expert in following that market. We're seeing that retrenchment occur, and we think that that's a positive for all the, the non-banks and the credit funds. There are far more community banks and regional banks than there are, commercial mortgage REITs and debt funds. We think that that will be a, a huge green shoot for us, and we are seeing inquiry on, in our origination team, to try to fill that void. We're not ready to step in yet. We want to maintain a certain amount of liquidity, but we are seeing some interesting transactions.
We haven't executed on any of them yet, as I said, but we think that's the big green shoot in the market. The retrenchment of the of the banks is going to be a huge positive. First thing we want to see is we want to see the Fed start to telegraph a pullback in rates.
Matthew Hallett (Equity Research Analyst)
Appreciate the update.
Operator (participant)
The next question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.
Steven Delaney (Managing Director and Senior Equity Analyst)
Good morning, everyone. Thanks for taking my question. Frank, in your remarks, I wrote in my notes that you said there were 3 risk, rated risk rank, 5 loans. When I'm looking at page 14, I see the 2 5-rated office loans, D.C. and Oakland, but I don't see a third 5-rated loan. Did I just hear that wrong?
Matthew Wallach (COO)
... No, there are 3 loans. You may recall last quarter, we reported on a property in Milpitas that was split into a mezzanine A and a mezzanine B, and we took a full reserve on the mezzanine B, and that remains a risk rank 5 loan.
Steven Delaney (Managing Director and Senior Equity Analyst)
Okay. It's just not in the deck. Is that what you're saying?
Andrew Witt (President and COO)
That's getting me.
Matthew Wallach (COO)
Huh?
Andrew Witt (President and COO)
Yeah, that's right. It's not in there. It's written off and-
Matthew Wallach (COO)
Yeah, that's right.
Steven Delaney (Managing Director and Senior Equity Analyst)
Okay.
Matthew Wallach (COO)
That's correct.
Steven Delaney (Managing Director and Senior Equity Analyst)
Okay, the exposure's off.
Matthew Wallach (COO)
That's right.
Steven Delaney (Managing Director and Senior Equity Analyst)
Okay. Okay, got you. That's helpful clarity. Then what were the issues? I noticed, and Mike referred to this, that you had three, I believe, Multifamily loans that you took to 4, and they're now on the watch list. Is there any common theme there into what was going on with those properties and the operators that caused you to push those three Multifamilies to a 4? It looks like they're all out west somewhere. I don't know if that's a common theme.
Michael Mazzei (CEO)
Yeah, all those loans are current. Andrew, do you want to answer this?
Andrew Witt (President and COO)
Sure, Mike. These are all, loans in, in different and distinct markets.
Michael Mazzei (CEO)
Mm-hmm
Andrew Witt (President and COO)
... in, in certain respects, different things going on. But I would say generally across multifamily, which our portfolio has about 52% exposure to-
Michael Mazzei (CEO)
Yeah.
Andrew Witt (President and COO)
The asset class is performing rather well.
Steven Delaney (Managing Director and Senior Equity Analyst)
Sure.
Andrew Witt (President and COO)
What we are seeing is an uptick in the expense side, so G&A is up. Then if you look at certain markets, property tax, insurance, and even down at the municipality level, utilities can be up. There have been challenges. Then additionally, as Mike highlighted in his prepared remarks, there has been, in certain properties, an increase in bad debt as a result of COVID kind of lenient policy. So that's gotten in the way of the borrower's ability, in certain cases, to clear out bad debt, to take possession of certain units and make the improvements and execute on their business plan. That essentially is elongating the period of negative cash flow. So we, we looked at these four investments and felt like they were behind a business plan.
As evidenced in this quarter's risk ranking movements, we've seen, you know, positive movement in certain assets. That could certainly be the case here. As Mike highlighted, we want to be upfront with these potential issues and make, you know, make sure there are no surprises. Those are kind of the.
Steven Delaney (Managing Director and Senior Equity Analyst)
Yes
Andrew Witt (President and COO)
... the, the, the general themes.
Steven Delaney (Managing Director and Senior Equity Analyst)
Yeah, that's a great color.
Michael Mazzei (CEO)
I would add.
Andrew Witt (President and COO)
I will-
Michael Mazzei (CEO)
I will add to that.
Andrew Witt (President and COO)
I will add that what we are seeing is we are seeing good rent growth.
Steven Delaney (Managing Director and Senior Equity Analyst)
Yes.
Andrew Witt (President and COO)
On the top line, despite, you know, some of the headlines, in our portfolio, kind of on a same store basis, we've seen year-over-year about a 6% increase. That's taking out the, the units that have been renovated. Those are obviously receiving much higher premiums, so we are continuing to see good rent growth.
Steven Delaney (Managing Director and Senior Equity Analyst)
Got it. That's helpful. Yeah, it doesn't it sounds like being an apartment rental manager is a lot more challenging these days than it may have been in the past. And we certainly understand with the COVID changes. Thank you guys for the comments, and good job.
Operator (participant)
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the queue. Our next question comes from the line of Matthew Erdner with JonesTrading. Please proceed with your question.
Matthew Erdner (Director and Equity Research Analyst)
Hey, good morning, guys. Thanks for taking the question. With the expectation that the San Jose hotel loan pays off next quarter, say, that goes through, would you be willing to originate at some of these higher yields to boost the overall coupon of the portfolio, and kind of jump back into the market, test the waters, and start originations again? If so, do you guys have a current pipeline that you're looking at and areas that you'd want to target? Thanks.
Michael Mazzei (CEO)
Thank you for the question. I just want to clarify that on that San Jose hotel asset, there is, under contract, one tower. There are two towers of the hotel. The second tower was built subsequent to the first. That tower is under a PSA for sale that has been since the spring, and that buyer is really not a-- it's a non-financial buyer. That buyer is. We're expecting that to close sometime, as I said, in September, October. The proceeds from that sale would go down, would pay down the first mortgage. We do believe that the buyer, the owner, is exploring sales options for the entire hotel, but we can't really speak to that at this point. We think that they're making that inquiry, but we don't have any details to report.
That's very early. We can't say that'll occur. Having said that, any, any delevering that we would have in that hotel would produce liquidity because we have such a, a, a low advance rate on it. I just want to be clear on that. The answer is, I think to get back on offense, what we are really looking at are two things. Not just that, but we're really looking at our overall liquidity and the portfolio needs. As we get over the next, quarter or two, more visibility as to what liquidity we need to protect the portfolio, that'll be the number one sign that we have for getting back into the market. That timing probably also occurs with the Fed starting to say that they're going to, or they can see easing going forward.
As we get toward the end of the year, we think that the prospects of playing on offense are, are increasing dramatically, and that we'll have the cash to do so. Given the leverage of the firm, as we said in the stated remarks, is 1.9x leverage. We think we're one of the lowest levered mortgage REITs in the, in the peer, in the peer group. In terms of opportunities, as I said earlier, the, the regional bank pullback, I think, is going to be massive. It's very difficult to understand how much they were doing because there were just so many banks in the market, literally thousands of them making loans. There were banks I've never heard of that were doing loans in, in, in areas well outside of their region.
We think that those will present big opportunities. In terms of sectors, obviously, given our office exposure today and what's going on in the office market, we would be hyper selective in office. In terms of multifamily, hotel, industrial, other property types, we'd be absolutely open to doing that, including doing some construction loans, because we think that the regional banks were very heavy in construction lending. We think there'll be good selective opportunities to do construction loans, and that, that'll be a product very, very well needed. We think overall, for the market to start to move, not only on the, on the, on the supply side with the regional banks pulling back, but we also need to see an increase on the demand side for credit.
We think that's not going to happen, broadly until assets start to trade, and until we start to see rates on the short end coming down.
Steven Delaney (Managing Director and Senior Equity Analyst)
Thank you. That's helpful.
Operator (participant)
There are no further questions at this time, and I would like to turn the floor back over to Michael for any closing comments.
Michael Mazzei (CEO)
Great. Well, thank you all for joining us today. Please, as always, feel free to reach out and contact us if you'd like to have a one-on-one meeting. We'll try to accommodate. Until then, we'll see you in the third quarter call in November. Have a great rest of summer. Thank you.
Operator (participant)
Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.