Lument Finance Trust - Q2 2023

Transcript

Operator (participant)

Good morning, and thank you for joining the Lument Finance Trust Q2 2023 earnings call. Today's call is being recorded and will be made available via webcast on the company's webcast. I would now like to turn the call over to Andrew Tsang with Investor Relations at Lument Investment Management. Please go ahead.

Andrew Tsang (Head of 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, James Briggs, CFO, James Henson, President, and Zach Halpert, Senior Director of Portfolio Management. Yesterday, on Tuesday, August 8th, we filed our 10-Q with the SEC and issued a press release to provide 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'd like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

When used in this conference call, 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 statement. 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.

Jim 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. Start with the market. With respect to the overall multifamily market, market, during the first half this year, we've observed decrease in demand and, and a slight rise in vacancy rates, resulting in some modest rent growth of approximately 1% a-across, across the portfolio. It's important to note that, that's a national trend and doesn't apply uniformly to all metro areas. Some cities we've seen flat or negative rent growth. You know, some of the, the bigger gainers over the years, Vegas, San Francisco, Phoenix. Others, we've seen rent growth of right around 2%, historic averages.

We've seen that in Boston, San Diego, Knoxville, cities like that. There's, there is, there is certainly a, you know, as, as is typical, 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. Multifamily economic backdrop remains constructive, positive job growth, elevated single, single-family prices and affordability, in many locations across the country, and obviously 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 suppressed, we are seeing some stability in rent conditions, and positive, albeit slowing, net operating income growth.

We view these signs of increasing stability in asset valuations 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 LFT 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 shares similar matched-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 term 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 works out to 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 managed transaction structure that significantly increases our levered investment capacity at attractive economic terms.

We are cognizant 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 matched-term and non-mark-to-market, including the collateralized financing transaction we closed subsequent to the end of this quarter. Further, 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 details on our financial results. Jim?

Jim 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. Supplemental investor presentation has been uploaded to the webcast as well for your reference. On pages 4 through 7 of the presentation, you will find key updates and 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 PNL. 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. 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 the 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 prepayment-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 us pivoting from. Given volatility in the capital markets and significant execution risks, we determined to terminate this transaction before it went to market and instead pursue the transaction 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 items, these charges are adjusted out for purposes 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.

75% 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 3.2, 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 five.

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 five. 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 twelfth. All of these loans, were collateralized by multifamily properties. 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 twelfth transaction.

As discussed earlier on the call, we expect to continue to rely on the depth and breadth of our managers' 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.

Jim Flynn (CEO)

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

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press Star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star, then two. The first question comes from Crispin Love of Piper Sandler. Please go ahead.

Crispin Love (Senior Research Analyst)

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

Jim Flynn (CEO)

Thanks for the question. I, I, I think there's a little bit of a blend. We've actually seen, across our broader platform, some higher payoffs, frankly, than we would, might have expected a quarter ago or two. We actually do expect, you know, a reasonable amount of payoffs coming here, over the next couple of quarters, as you point out. We also expect to, to have, some loans extend with, pay downs and, and, you know, other, you know, terms changing, on the lender's behalf to, to get those executions.

And, you know, it's, it's gonna be a mix, but we're in all of the borrowers that we've been speaking with, you know, we've generally had constructive and positive conversations where we expect their plan is to either move forward with a sale, and which will get paid off or have plans to refinance at, at lower leverage.

Crispin Love (Senior Research Analyst)

All right, thanks. I appreciate the color there.

Jim Flynn (CEO)

Sorry, not refinance, extend. Excuse me. Yeah.

Crispin Love (Senior Research Analyst)

Yeah, yeah. Okay. Jim, I think you may have mentioned this in the prepared remarks, but I might have missed it. At quarter end, your cash balance was just under $99 million. The pro forma cash balance, inclusive of LMF 2023-1, did, did you say that was $40 million?

Jim Flynn (CEO)

Forty.

Crispin Love (Senior Research Analyst)

Is it a similar balance? Excuse me, 40?

Jim Flynn (CEO)

Yes, 40. Yeah, that's right.

Crispin Love (Senior Research Analyst)

Okay.

James Henson (President)

40. That's right, Crispin.

Crispin Love (Senior Research Analyst)

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

Jim Flynn (CEO)

... I would say we were, we were, we were very close. You know, the, the reasons why we were not able to get that transaction done are, you know, SVB, Signature Bank, BS. We were, we were very close to getting a launching a public deal or potentially even, you know, placing it in, in direct accounts when, you know, all of the banking noise and crisis kind of really blew up. I mean, we were, we were ready to go. I mean, it was days or weeks, and. We did continue to explore. We had kind of we had been dual tracking, looking at different ways. We've talked in the past about looking at private transactions.

We had known, you know, the, the capital markets have been so, you know, volatile and, you know, they opened and closed infrequently and for short periods, that, that we had, we had been anticipating a little bit of both. At that time, we thought we had a window to get the trade done. Our bankers thought so as well. Closed very quickly. We, you know, we continued to see if, you know, we would get another window, but, but, you know, the, the shoes kept dropping there on the, on the banking side. You know, spreads, even if you could get one done, spreads blew out. We weren't, we probably would not have been able to do a, a, dynamic or reinvest, have a reinvestment period. Things kind of moved against us pretty quickly.

We pivoted back to the private transaction and just kind of went full steam ahead to, to get that done, you know, right around that time. Unfortunately, we were close. You know, it was, again, a static deal. I think at the time, I would expect pricing maybe would have been a little bit better. You know, as soon as the market changed, it was either worse or not even achievable at all.

Andrew Tsang (Head of Investor Relations)

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

Operator (participant)

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

Stephen Laws (Equity Research Analyst)

Hi, good morning.

Jim Flynn (CEO)

Morning.

Stephen Laws (Equity Research Analyst)

Yeah, congratulations on the private deal in July. I know it's financing something you guys have been looking at for a number of quarters now, so, you know, I know you were happy to see the deal executed. You know, as I think about it, and on your last point about it being, you know, a managed collateral pool, you know, the reinvestment period is still open in your first CLO as well, obviously, through year-end. Can you talk about how accretive any turnover is? You know, what are your typical spreads you're seeing on maturing loans that are paying off versus where that can be redeployed?

Jim Flynn (CEO)

Yeah, I think, you know, it's obviously a little bit better. We've had, you know, most of the loans paying off would have, you know, 3 handles on them, mid and high 3s. You know, I think new loans, I think that 4 to 4.50, 4.25 has, has kind of been where loans that are getting done or that are trading have been, have been kind of in that range. There should be a modest pickup. You know, I would expect kind of lower leverage that we've seen in the market as well. But, it's not. It'll be a modest pickup, but it's, you know, 25 to 50 basis points would be probably my guess on average. Depends on the payoff.

Stephen Laws (Equity Research Analyst)

Great. Then just I want to make sure we, we've still got just the one 5-rated loan, that didn't change, but it looks like 4-rated loans dropped.

Jim Flynn (CEO)

Right.

Stephen Laws (Equity Research Analyst)

-from 12 to 10. I think I'm guessing maybe one was the retail loan that I think you mentioned in your prepared remarks, but I may be wrong on that. Can you talk about what you're seeing in that four bucket? You know, any trends, geographic or, you know, you're mostly multi, so, you know, any geographic trends, and is there any correlation with sponsor concentration among those?

Jim Flynn (CEO)

No. I'll actually introduce Zach Halpert to, to, to give you guys some color on that. Just on, Stephen, on the last question, I do want to-- As I said, the, the new transaction was, you know, equated to spreads of about 425 based on what we paid for them.

Stephen Laws (Equity Research Analyst)

Mm-hmm.

Jim Flynn (CEO)

I was-- New transactions for our first CLO, excuse me, payoffs have been around $360 million in that, in that pool as loans are paid off. My, my point around reinvestment and the pickup in spread is for-- is really related to the first CLO, not the second.

Stephen Laws (Equity Research Analyst)

Sure. Yeah, got it.

Zachary Halpern (Senior Director of Portfolio Management)

Hey, Stephen, this is Zach.

Jim Flynn (CEO)

Yeah, go ahead, Zach.

Zachary Halpern (Senior Director of Portfolio Management)

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

Stephen Laws (Equity Research Analyst)

Great. Appreciate the comments this morning.

Jim Flynn (CEO)

Thanks, Stephen.

Operator (participant)

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

Matthew Erdner (Senior Research Analyst)

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

Jim Flynn (CEO)

It's, it's full, today.

Matthew Erdner (Senior Research Analyst)

Okay.

Jim Flynn (CEO)

We, we do expect to have a couple of payoffs here in the next couple of months. It just, it, it really depends on-- it depends on whether those happen in time. You know, we could see, you know, reasonably, you know, a, a, a reasonably high number. We've got assets in our queue that we're reviewing that we can move in there. We're, we're, we're trying to push people to, if they're going to pay off, to, to get it done as quickly as possible so that we're able to, you know, put new assets in the, into that securitization. I will say, in general, even though we've seen elevated payoffs, they've almost all taken longer than originally projected by the, the, the owners.

We, excuse me, but we are very actively managing and engaging with sponsors to... Not just on payoffs, but obviously that's a critical component right now, but just in general. We have a pretty good finger on the pulse, but, but sometimes, you know, buyers and sellers, some of it's out of, out of our control. I do expect to see, you know, some meaningful payoff here, before the end of the year, that we, we are, you know, optimistic we'll be able to, to put new deals in in time. It's all, it's all a time game. After that, it will be, you know, just, just deleveraging the pool.

Matthew Erdner (Senior Research Analyst)

Okay, thank you. 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?

Jim Flynn (CEO)

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

Matthew Erdner (Senior Research Analyst)

Thanks for taking the questions.

Operator (participant)

As a reminder, if you have a question, please press star one. The next question comes from Christopher Nolan of Ladenburg Thalmann. Please go ahead.

Christopher Nolan (SVP)

Hi. For the new financing, how much do you expect this to add to EPS in 2024?

Jim Flynn (CEO)

Hang on. Jim Briggs, do you wanna provide some details?

Jim Briggs (CFO)

Yeah, I mean, we've, we've, we've generally not guided, from, from, from that perspective. You know, I think you can look at the transaction, you know, both the, the leverage, the costs, and, the effective spread, that Jim's talking about there, and, and make some estimates.

Christopher Nolan (SVP)

Great. Then on a follow-up on that, I think Jim Flynn mentioned an investment spread of 425 basis points. If I heard correctly?

Jim Flynn (CEO)

For the financing that we just completed, we've, we acquired those loans at a discount. You know, we equate that to approximately 425 or just north.

Christopher Nolan (SVP)

Okay, which is above... The Q says 365 spread, so-

Jim Flynn (CEO)

Right. 365 is the stated, you know, nominal spread.

Christopher Nolan (SVP)

Right.

Jim Flynn (CEO)

The, the, the spread equivalent with discounted fees is, is what we're estimating to be about 425.

Jim Briggs (CFO)

Yeah, I mean, Chris, we, we, we mentioned, just to follow up on that point, that we acquired the loans from an affiliate of our manager, the majority of our loans, at a discount to, to par of 1.5% or $5.9 million, which is driving that effective spread north of 4.25%, that Jim just mentioned.

Christopher Nolan (SVP)

Okay. Is it fair to say the advance rate on the new financing is slightly below the. I, I get 82%, but I just want to make sure I'm in the ballpark.

Jim Briggs (CFO)

That's right.

Christopher Nolan (SVP)

Final question, on provisions. Given the new financing, what's the loan loss provision policy on that is? What's driving incremental provisions? Is it the rating on the debt? Is it debt service coverage, or...? A little color on that would be appreciated.

Jim Briggs (CFO)

As I mentioned in my remarks, most of the, the change we saw in the quarter is primarily being driven by changes in the macroeconomic forecast, right? CECL requires you to have a reasonable, and supportable forecast period, which we consider to be a year. So that, that forecast, has, has just gotten a little bit more, more negative. The risk rating migration was, was pretty modest for this quarter. So it's, it's primarily changes, in, in, in the macro forecast. You know, different quarter could give a different answer, but this quarter was primarily the, the macro forecast move.

Christopher Nolan (SVP)

Okay. Thanks, Jim. Thanks, guys.

Jim Flynn (CEO)

Thank you.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to James Flynn for closing remarks.

Jim Flynn (CEO)

I just want to thank everyone for joining, expressing interest. We're happy and pleased with, getting the transaction done, and look forward to speaking to you all next quarter. Thank you.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.