Lument Finance Trust - Q4 2022

Transcript

Operator (participant)

Good morning, and thank you for joining the Lument Finance Trust Fourth quarter 2022 Earnings Call. Today's call is being recorded and will be made available via webcast on the company's website. I would now like to turn the call over to Charles Duddy with Investor Relations at Lument Investment Management. Please go ahead.

Charles Duddy (Managing Director)

Thank you, good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust Fourth Quarter 2022 Financial Results. With me on the call today are James Flynn, CEO, Michael Larsen, President, and James Briggs, CFO. On Thursday, we filed our 10-K with the SEC and issued a press release which provided details on our four-fourth quarter results. We also provided a supplemental earnings presentation which can be found on our website. Before handing the call over to Jim, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

When used in this conference, words such as outlook, evaluate, indicate, believes, will, anticipates, expects, intends, and other 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 are discussed in the company's reports filed with the SEC, including its reports on Form 8-K, 10-Q, and 10-K, and in particular, the risk factors section of our 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 statements. Furthermore, certain non-GAAP financial measures will be discussed on this call. Presentation of this information is not intended to be considered in isolation, nor as a substitute to the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP measures to the most comparable measures, prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. I will now turn the call over to James Flynn. Please go ahead.

James Flynn (CEO)

Okay. Thank you. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the fourth quarter of 2022. Thank you for joining. I'd like to first begin by addressing the economic environment. obviously, more news today, that we're all paying attention to. The multifamily market has continued to experience a transition as lenders and investors react to the higher interest rates, the economic uncertainties, the capital markets, and overall volatility. Investment activity has declined relative to 12 months ago as buyers and sellers work to reassess financing costs and find a new normal for levels of asset valuations and financing structures. We've seen, you know, just anecdotally, you know, 17% year-over-year decline in transaction volume on the investment sales side, quarter-over-quarter.

If you go back to the fourth quarter, you saw almost 70% decline. You've seen obviously a significant decline in just market activity. However, despite the lending recessionary indicators increasing and potential negative impacts of the ongoing banking crisis, the employment market remains relatively strong and supportive of continued rent growth for many multifamily assets, although we do see a slower rate than we've seen over the previous two years. While the margin may be thinning, we do continue to expect rents to generally outpace expenses in most of our markets and believe the credit quality of the middle market workforce housing asset remains attractive. That middle market housing supply-demand dynamics, demographics, and long-term rent growth trends do create and continue to create an attractive investment opportunity for shareholders over the long term. Our multifamily investment portfolio has performed well.

While we did book an additional unrealized loss reserve against our sole office loan this quarter, which we ultimately realized last month, and which we'll discuss later during the call, the remainder of our book continues to perform well overall. More specifically within the bridge lending market, lending standards have continued to tighten. Pricing on new loans has increased industry-wide over the past several quarters. We do expect the average spread on LFT's investment portfolio to continue to increase. As the portfolio grows, we experience payoffs and are able to reinvest in our existing CLO. With all that backdrop, the broader capital markets have remained extremely volatile. Conditions in the CRE CLO market very recently showed signs of encouraging trends relative to where they've been.

However, the market for new issuance has become significantly more uncertain over just these past few weeks due to the developments in the banking industry. In order to continue to grow our portfolio on a levered basis, to fully deploy our capital, and to take advantage of our managers' origination capabilities, we remain actively focused on executing a loan financing track transaction to leverage newly acquired loans. We've historically utilized the CRE CLO market to finance our investments and continue to believe that market provides an attractive financing source due to the favorable leverage as well as non-recourse, non-mark-to-market features. While we're prepared to execute a CLO quickly to the extent the market conditions change and improve, we are actively exploring alternative financing options, including private transactions, note-on-note financings, A note structures, and warehouse facilities.

With regard to our dividend, on 16th March we declared a quarterly common dividend for the first quarter of 2023 of $0.06 per share. This is in line with our dividend level over the prior four quarters. We continue to anticipate that we will have the ability to increase our dividend at such a time that we're able to execute a loan financing transaction. We continue to focus on deploying our capital into the CRE debt investments with a focus on multifamily.

As you know, our manager is one of the nation's largest capital providers in the multifamily and seniors housing space, executing over $10 billion in total transaction volume in calendar year 2022, servicing a $48 billion portfolio and employing approximately 600 employees in over 30 offices nationwide. That scale and expertise of the manager's broad platform will continue to benefit the investors of LFT. With that, I'd like to turn the call over to Jim Briggs, who will provide some details on our financial results. Jim.

Jim Briggs (CFO)

Thank you, James. Good morning, everyone. On Thursday evening, we filed our annual report on Form 10-K and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. The supplemental investor presentation has been uploaded to the webcast as well for your reference. On pages four through eight of the presentation, you will find key updates and an earnings summary for the quarter. The fourth quarter of 2022, we reported net income to common stockholders of approximately $880,000 or $0.02 per share. We also reported Distributable Earnings of approximately $3.3 million or $0.06 per share. This compares favorably to the Distributable Earnings of $1.7 million or $0.03 per share in the prior quarter. There are a few items I'd like to highlight with regards to our Q4 P&L.

Beginning with net interest income, our Q4 net interest income was $6.9 million, compared to $5.5 million in Q3 of 2022, which represents a significant 26% increase quarter-over-quarter. This increase was primarily driven by higher LIBOR and SOFR rates. During Q4, LIBOR averaged 3.88% versus an average of 2.46% during Q3. Short-term interest rates continue to increase, which we expect will continue to benefit LFT's earning profile over the coming quarters. During Q4, we experienced $45 million of loan payoffs, which represents an increase relative to $34 million of loan payoffs during Q3. $45 million of payoffs experienced during the quarter represents a 17% annually annualized payoff rate.

While this payoff rate is below our long-term historical averages, we expect to continue experiencing similar payoff speeds over the coming quarters due to persistent interest rate volatility and economic uncertainty. The primary difference between our distributable and reported net income during Q4 was a $2.4 million provision for loan loss. In Q4 of this year, we recorded a provision for loan loss of $2.4 million or $0.05 per share on the $10.3 million dollar loan collateralized by an office property in Chicago, which we have discussed in prior quarters. The loan was originated in July of 2018, and as of year end, was LFT's only office property investment.

We had previously entered into a forbearance agreement with the borrower, extending the maturity date to December 2022 to allow the borrower more time to market and sell the property. The borrower was unable to execute a sale in that timeframe. Subsequent to year-end, on 27th February the property was ultimately sold via auction for $6 million, and we accepted a discounted payoff from the borrower in that amount. Having established a total of allowance of $4.3 million during the course of 2022 on that loan, we will not incur any further negative impact to book value or GAAP EPS in 2023 as a result of the discounted payoff we accepted.

While we expect no impact to book value or GAAP EPS from this asset and disposition in 2023, we do expect a $4.2 million negative impact to Distributable Earnings in Q1, reflecting the realized loss as unrecoverable. During the period ended 31st December we identified one additional loan collateralized by a multifamily property and with an unpaid principal balance of $12.8 million as impaired due to monetary default, and we individually evaluated that asset. No reserve has been recorded based on an analysis of the underlying collateral. This loan is on non-accrual status. We are pursuing all remedies on this asset. As Jim mentioned in his opening remarks, the remainder of our loan portfolio continues to perform.

Other than the provision taken this quarter on the office loan, which is now resolved, we have not taken any other loss provisions. Moving on to expenses, our total expenses were $2.5 million during Q4, which represents a decline relative to total expense of $2.7 million during Q3. As of 31st December the company's total book equity was approximately $243 million. Total common book value was approximately $183 million or $3.50 per share. As I've discussed in prior quarters, I would like to remind everyone that as a smaller reporting company as defined by the SEC, as of 31st December and through this 10-K, we have not yet adopted ASU 2016-13, commonly referred to as CECL, or Current Expected Credit Losses, which is a comprehensive GAAP amendment of how to recognize credit losses on financial instruments.

Our recently filed financial statements were prepared on an incurred loss model basis. We disclosed in the 10-K upon adoption of CECL on 1 January 2023 of this year. We expect that based on current expectations of future economic conditions, our general allowance for credit losses on loans held for investment, including future loan funding commitments, will be between $3 million and $4 million, or 30 basis points and 40 basis points of the company's total loan commitment balance of $1.1 million as of 31st December. This implementation impact will be recorded as an adjustment to 2023's opening accumulated earnings balance. I'll now turn the call over to Mike Larsen, who'll provide details on our portfolio composition and investment activity.

Michael Larsen (President)

Thank you, Jim, and good morning, everyone. As Jim Flynn touched on earlier, the broader economic conditions which have continued to be volatile and uncertain, have driven a decline in new acquisition activity. It also expressed the number of bridge loan opportunities that support the current in-place cost of financing that exists in the market. At the same time, we have seen and expect payoff speeds to temper in the near term, reducing our capacity for new investments relative to previous quarters and years. We anticipate that trend to continue throughout 2023, while interest rate increases moderate and the general real estate markets reset to new higher interest rate environment. During Q4, LFT directly originated five new investments with a total unpaid principal balance of $75.6 million.

Four of these new investments were supported by senior housing assets. One was secured by multifamily asset. The new loans acquired this previous period were indexed to 30 Day Term SOFR and had a weighted average spread of 398 basis points. That level represents a meaningful increase relative to the current portfolio weighted average spread of 343 basis points. New acquisitions had a weighted average index rate floor of 82 basis points. This is also an increase relative to our average of our portfolio of 37 basis points. The acquired loans had a weighted average LTV at origination of 55%, which is, we believe, attractive leverage point and is below our portfolio average LTV of 71.5%.

As mentioned, we experienced $45 million of loan payoffs during the quarter and at quarter end, our total loan portfolio announcing principal balance of $1.1 billion. That's a 3% increase in portfolio size quarter-over-quarter and a 7% increase relative to the fourth quarter of 2021. The portfolio consists of 71 loans with an average loan size of $15 million, which continues to provide for significant asset diversity. Our portfolio at quarter end was 90% multifamily. It's important to note our exposure to retail and office continue to remain very low at only 2% of our total at year-end and 1% after the payoff of the last office property and portfolio. Again, currently we have no office exposure in the portfolio.

Due to our managers' strong focus in multifamily and seniors housing, we continue to anticipate the majority of our loan activity will be related to those asset classes. Our investment return profile has a strong positive correlation with rising interest rates. We have included a rate sensitivity table on page 11 of our supplemental earnings presentation. Overall, we expect LFT to benefit from elevated short-term interest rates as the Fed continues to battle inflationary pressures. Since quarter end, the one month Term SOFR rate has increased from 4.39% to 4.76% today.

While there is currently uncertainty around further increases in short-term rates, we anticipate a continued positive P&L impact from elevated rates in the short term at LFT. As of 12/31, our loan portfolio was financed with one series CLO securitization that has a weighted average spread of 143 basis points over one month LIBOR and an advance rate of 83.375%. CLO has a reinvestment period running through December of 2023 that allows principal proceeds from repayments of assets to be reinvested in qualified replacement assets subject to various conditions. With that, I'll pass the call back to Jim for some closing remarks.

Jim Briggs (CFO)

Thanks, Mike. Well, we look forward to continuing to update on our progress. Obviously things are changing on a daily basis, and look forward to some more stability in the market. With that, I'd like to open it up to questions from the participants.

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're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Stephen Laws from Raymond James. Please go ahead.

Stephen Laws (Managing Director)

Hi, good morning. I guess, Jim Briggs, I'll start. Appreciate all the color on the office loans. That answered a lot of my questions around the modeling, appreciate that. With the CECL implementation, I just wanna make sure I'm clear there. The $3 million to $4 million impact, will that run through the income statement and then be added back in Q1, or only any change versus that 1 January adjustment that would run through the income statement?

Michael Larsen (President)

Stephen, it will be just a change from that number. We're anticipating our opening adjustment to equity retained earnings with no P&L impact will be within that range. Then it will be any change from that in the quarter.

Stephen Laws (Managing Director)

Right

Michael Larsen (President)

because of moves in the portfolio, moves in the economic forecast and other factors that go into the calculation.

Stephen Laws (Managing Director)

Great. That makes sense. I just wanted to make sure I was understanding that correctly. To move maybe to the originations, you know, the four loans, I think, in investments with healthcare. Can you talk about, you know, what you're seeing there that makes it attractive relative to multifamily? Was this just a unique quarter and maybe too small of a sample size to read anything into?

I know the deck, you know, obviously clearly states multifamily will remain the primary focus. Maybe as a follow-up on the new investment activity, you know, LIBOR floors on those were under 100 basis points and, you know, a little surprised they're that low. Are you not focused on that, more focused on maybe the 55 LTV metric you put out? Can you talk about the things you're pushing for in new loans and kind of how you prioritize those things?

Michael Larsen (President)

Sure. I mean, I'll take first on the

Stephen Laws (Managing Director)

Sure

Michael Larsen (President)

On the seniors housing piece of it. Just a couple points there. We've discussed in the past, our manager is one of the largest providers of financing in the seniors housing healthcare space. We do see significant opportunities in that space, although we are focused on multifamily investments. We recently did see some attractive opportunities, as you said, lower leveraged, and made those investments last quarter. You know, the dynamics of healthcare properties tend to have much higher debt yields and dynamics that support bridge financing in this market. These assets we thought were a good opportunity for LFT to continue to grow the portfolio despite the decline in transaction activity that we've seen. I don't expect a significant increase in seniors housing and expect our continued focus to be on multifamily.

Stephen Laws (Managing Director)

Great. One last one, if I might. A quick one. Any seasonality expenses to think about Q1, related to filings or the CLO that you're looking to get done that model in?

Michael Larsen (President)

I had a little bit of trouble. Can you repeat that question?

Stephen Laws (Managing Director)

Sure. Any seasonality we need to think about with expenses in Q1 related to, you know, year-end, SEC filings or auditing or potentially with the CLO deal that's in the market that we should include in our model from an operating standpoint?

Michael Larsen (President)

Jim Briggs, you can speak to the audit. I don't believe anything, that's different than what we've seen in past years.

James Flynn (CEO)

No, I think that's correct.

Stephen Laws (Managing Director)

Great. Appreciate the comments this morning.

Operator (participant)

If you have a question, please press star then one. Our next question comes from Jason Stewart from JonesTrading. Please go ahead.

Jason Stewart (Managing Director)

Great. Good morning, guys. Thank you. On the multi side, what kind of transition rates are you seeing from Class A to B to C? You know, if you can talk to that and maybe how that impacts your portfolio.

James Flynn (CEO)

When you say transition rates, you mean available investment opportunities?

Jason Stewart (Managing Director)

No. Well, I'm looking actually for color on the underlying resident movement. Who's going from Class A to B to C? Does that improve occupancy-

James Flynn (CEO)

Yeah. Okay.

Jason Stewart (Managing Director)

physical, et cetera?

James Flynn (CEO)

Yeah. I think I mean, look, you obviously have to look at each market and micro-market. In general, historically, we found that there's less volatility in occupancy at the, you know, what we've largely described as workforce housing, which, you know, B, C, and even if you slip into the affordable space. The primary reason for that is the supply-demand demographics are balanced. It's far out of whack. I don't know that we're there yet to fully identify a trend. Typically, in a time of distress, whether it's recessionary or just kind of economic downturn, that you're, you know, you're more likely to see more people looking for more affordable housing than where they currently live.

Jason Stewart (Managing Director)

Right

James Flynn (CEO)

The other way.

Jason Stewart (Managing Director)

Right.

James Flynn (CEO)

I would continue to expect. Yeah, you know, we do have new builds coming online in certain markets, and they're gonna be newer and nicer, and so they'll probably or in many cases will lease up, but that may be to the detriment of their. You know, the comp set in the area. In general, you know, the occupancy levels at those mid and lower level apartments, which is obviously the majority of where we operate, is generally improves or remains more stable, is probably a better word, in times of distress.

Jason Stewart (Managing Director)

Yeah, I would expect that too. Okay, that's helpful. Then how would you characterize the takeout financing for transitional projects right now? I mean, Fannie does. Freddie K seems to be a little bit illiquid. How would you characterize the ability to get out of a project?

James Flynn (CEO)

I think that what you just said is true of the agencies. We've certainly seen an uptick of a lot of folks looking at more deals. I think. There's also, again, very recent history, you know, past couple of months, more interest expectation on borrower sides of coming in with cash to put long-term financing on. The banking crisis that's ongoing, and the impact on community banks and regionals, I think is only going to further exacerbate that problem that you described around takeout financing. I think, you know, from our standpoint and what we've seen in general, you look at the trends in the space, you look at the long-term prognosis for multifamily, and, you know, it's still, from our perspective, a long-term attractive asset.

I think owners feel the same way, certainly a naturally optimistic group, that there's a, there's a bit more acceptance of trying to perhaps accepting that they may need to give up some of their equity or potential equity gains in order to lock in reasonable and attractive long-term financing. That can be in the form of a cash in if they're well capitalized or able to raise capital fairly easy. It can also be meaning at the common level. I think we've seen a significant uptick in the interest for preferred equity and/or Mezz throughout the industry.

We've seen deals getting done, but I know that there's just a lot more borrowers that are looking to bring in a new partner, execute the business plan and hold the asset maybe longer than they originally planned, but with new equity and longer term debt. I do think we're gonna need to see a lot of that, for most bridge loans. You know, an 80 or even an 80 LTV bridge loan is not going to get an 80 LTV 10-year loan. So there's

Jason Stewart (Managing Director)

Right.

James Flynn (CEO)

There's value protection there, but they are going to need, you know, cash infusion in either the form of common or some other subordinate capital. The good news is, from a borrower standpoint, is there's a lot of that capital that's either out there being raised or lenders and others expressing interest to do so.

Jason Stewart (Managing Director)

Got it. That's helpful. Thank you.

Operator (participant)

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

James Flynn (CEO)

I just wanna thank everyone for joining. I know it's another hectic morning. We will continue to be in touch, and look forward to speaking to you all again soon. Thank you.

Operator (participant)

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