Claros Mortgage Trust Inc (CMTG) 2024 Q2 法說會逐字稿

Welcome to the Claros Mortgage Trust second-quarter 2024 earnings conference call. My name is Jaquita, and I will be your conference facilitator today. (Operator Instructions)

I would now like to hand the call over to Anh Huynh, Vice President of Investor Relations for Claros Mortgage Trust. Please proceed.

Thank you. I'm joined by Richard Mack, Chief Executive Officer and Chairman of Claros Mortgage Trust; and Mike McGillis, President and Chief Financial Officer and Director of Claros Mortgage Trust. We also have Priyanka Garg, Executive Vice President, who leads MRECS Portfolio and Asset Management.

Prior to this call, we distributed CMTG's earnings release and supplement. We encourage you to reference these documents in conjunction with the information presented on today's call. If you have any questions, please contact me.

I'd like to remind everyone that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them.

We will also be referring to certain non-GAAP financial measures on today's call, such as distributable earnings, which we believe may be important to investors to assess our operating performance. For reconciliations of non-GAAP measures to their nearest GAAP equivalent, please refer to the earnings supplement.

I would now like to turn the call over to Richard.

Thank you, Anh, and thank you, everyone, for joining us this morning for CMTG's second-quarter earnings call.

It's been more than two years since the Fed started raising interest rates in response to rising inflation. And it's not been an easy run for the commercial real estate industry to say the least. When we take a step back and look at the broader picture, we can see many variables at play. Property owners have not had the pricing power of other industries that were able to pass on rising costs to consumers, falling demand for office space, and additional supply coming online in multifamily and industrial have coincided with dramatic increases in real estate expenses and capital costs.

This has translated into real estate values falling rapidly across the board. Commercial real estate takes time to build and time to start building. So it lags the economy. And in the short term, the industry has been disproportionately hurt by inflation and rate movements, but it can also result in outsized benefits when this pattern reverses. New construction has been dramatically reduced against the backdrop that features a generally resilient consumer, cooling inflation, and a broad-based market expectation that the Fed is poised to begin cutting rates.

Furthermore, many investors are also predicting a resumption of rent increases in both multifamily and industrial, given the limited new supply and sustained demand just as rates may start to fall. This double benefit impact has some investors calling the bottom especially since construction costs have also risen significantly.

Not surprisingly, then we are starting to see green shoots in the commercial real estate market, suggesting a more positive trajectory for the industry could be on the horizon. While it's still too early to declare sea change in investor sentiment, large and noteworthy transactions are getting done. Lenders are slowly returning to the market as new sources of private credit emerge. With this gradual increase in liquidity, albeit still muted from recent historical levels, we've seen borrowers successfully and willingly secure financing even in light of the elevated rate environment.

With regard to our portfolio, we continue to be constructive on the long-term outlook of the multifamily sector, which remains our largest portfolio concentration. We expect population growth, migration to many of our current and target MSAs, and limited housing supply will continue to drive the overall fundamental picture we are seeing in rental housing. Additionally, we have made meaningful progress towards improving value in our two REO assets, and we attribute this success to our management team's experience and hands-on asset management approach.

Looking ahead, many of the real estate industry expect that rate relief will re-energize the real estate capital markets providing valuation tailwinds for most asset classes. And while we remain focused on liquidity, we also believe that the optimism around the Fed reducing rates provides us a compelling opportunity to reevaluate how we are deploying and directing our capital in expectation of asset value increases.

Although the number of assets are nonaccrual and the watchlist increased this quarter, the rate of increase decelerated implying an improving cycle. In such an environment, we do not believe that the current portfolio designations reflect the inherent value of our portfolio over the medium to long term.

With all these factors in mind, our Board of Directors has decided to adjust our quarterly dividend to $0.10 per share beginning in the third quarter of 2024. We believe this decision enables us to pursue capital allocation strategies with the objective of preserving and enhancing book value while also positioning the portfolio for earnings growth.

Those capital allocation decisions may include investing in our current and potential future REO assets, paying down high-cost debt, buying back our term loan or buying back CMTG stock, which we believe is significantly undervalued at current price levels.

I would now like to turn the call over to Mike.

Thank you, Richard.

For the second quarter of 2024, CMTG reported a GAAP net loss of $0.09 per share and distributable earnings of $0.20 per share. Distributable earnings per share prior to realized losses were $0.21 per share, which was in line with the first-quarter result of $0.20 per share. The New York City REO hotel portfolio had a stronger second quarter due to expected seasonality, which resulted in a $0.05 per share improvement in earnings compared to last quarter. This was partially offset by the impact of a New York land loan placed on nonaccrual during the quarter. I'll provide additional information on the nonaccrual loan later in the call.

beginning with the left side of the balance sheet, CMTG's loan portfolio grew slightly to $6.8 billion at June 30 compared to $6.7 billion at March 31. The quarter-over-quarter change is attributable to follow-on fundings of $143 million, offset by the impact of partial loan repayments totaling $41 million. At quarter end, our multifamily portfolio was unchanged compared to prior quarter, representing our largest exposure at 40% of the portfolio.

As Richard mentioned, the supply demand imbalance continues to benefit the housing market, and we remain bullish on the long-term fundamentals of this sector. However, borrowers continue to experience challenges as they are adversely affected by higher interest rates elevating their cost of carry among other items.

As a result, during the quarter, we downgraded three loans to a four-risk rating, representing a total carrying value of $370 million. Two of these loans with a UPB of $161 million are collateralized by multifamily assets located in the Dallas MSA with the same sponsor. The current interest rate environment has placed significant pressure on the sponsor's ability to effectively operate their broader portfolio.

The downgrades of these loans are driven primarily by this pressure on the sponsor rather than by underlying long-term real estate fundamentals. We are likely to take ownership of these assets along with other four-rated multifamily loans in the coming quarters. The third loan, which is unencumbered that was downgraded this quarter, was collateralized by a for-sale condo project in California.

In this instance, the sponsor, who relied on offshore capital sources, has experienced financial difficulty outside of this particular investment. Prior to defaulting on the loan, the sponsor successfully sold a number of condo units at levels well above CMTG's basis per square foot. However, the sponsor has experienced financial difficulty, and we have been working with them to find a path to resolving this loan, including a loan restructuring, loan sale our REO.

There were no new five-rated loans this quarter. We did, however, place an existing four-rated land loan on nonaccrual status. The loan has a carrying value of $88 million and is collateralized by a development site in New York City that is zoned for mixed-use building. This loan has been risk-rated a four since the fourth quarter of 2023 as the borrower has failed to make progress towards its business plan and has been delinquent in paying interest.

At June 30, total CECL reserves as a percentage of UPB increased to 3.1% compared to 2.6% for the prior quarter. Specific CECL reserves represented 23.1% of the UPB of our loans with specific CECL reserves. The general CECL reserve of 2.1% of UPB was comprised of 3.3% of the UPB on four-rated loans and 1.5% of the UPB on the remaining loans.

During the quarter, we recorded provisions for CECL reserves of $34 million or $0.24 per share. The increase in the general CECL reserve is primarily a result of increases in expected loan duration, increases and third-party historical loss rate data on similar loans, and to a lesser extent, changes in risk ratings and accrual status of loans in our portfolio.

Now turning to financing and liquidity. At June 30, we reported $191 million in total liquidity, which includes cash and approved and undrawn credit capacity based on existing collateral. Unencumbered assets were comprised of loans totaling $490 million of UPB, of which 94% were senior loans and our mixed-use REO with a carrying value of $146 million.

These unencumbered assets provide us with additional flexibility in maintaining our desired levels of liquidity. Subsequent to quarter end, repayment activity continues to accelerate. We received full repayments of three loans totaling $244 million of UPB, a $22 million loan collateralized by a build-to-rent portfolio, and $99 million loan collateralized by an industrial asset. And finally, a $123 million loan collateralized by a four-rated New York City office loan. This loan had been risk-rated four since the fourth quarter of 2023. The transaction reduced our office exposure and reduced our overall leverage.

Year to date, we have received a total of $873 million of loan proceeds through payoffs or loan sales. Of that amount, loans totaling approximately $646 million were construction loans. In addition, loans totaling approximately $400 million were risk-rated four, demonstrating continued progress in resolving watchlist loans.

Before turning the call to the operator, I'd also like to provide some additional color with regard to certain of our financing arrangements with the most restrictive financial covenants. During the second quarter, we significantly expanded our relationship with our largest financing counterparty while also completing covenant modifications on each of our repurchase facilities.

Overall, we reduced our minimum required interest coverage levels and tangible net worth covenant levels. We believe that these changes provide us with needed flexibility to preserve and enhance book value while also demonstrating our ability to work constructively with our various financing counterparties through challenging market conditions.

Operator, I would now like to open the call for questions.

Absolutely. We will now begin the question-and-answer session. (Operator Instructions)

Rick Shane, JPMorgan.

Good morning, guys. Thanks for taking my question. Look, I'd like to talk a little bit about the strategy on REO. In the past when you've had foreclosures, you've taken different paths, sometimes selling the property, sometimes managing them. And I think a lot has to do with the potential investment required. It sounds like you have some additional REOs coming your way, you reduce the dividend in order to enhance liquidity, and Richard made a comment about having capital to invest in the REO. I'm curious if that strategy is changing or if the REO that you intend to keep on balance sheet is going to be cash flowing positive?

Yeah. So let me let Priyanka discuss some of the details of the asset, but let me just -- Rick, thank you for your question. This is Richard. Let me respond to the macro. Our view at this moment is that we should be opportunistic around REO. I think in the past, we've been more focused on creating liquidity. But we now feel like this is the moment in time where we've got -- especially on the cash flow and multi, we want to be aggressive with borrowers.

And if they're not able to manage the property as well as we are and they're not putting cash in, we want to take those assets and write the value back up. We've only taken two assets back. That has been the right decision on both of those. We've been really careful about it. We're going to continue to be careful.

I think we're feeling at this moment that, and while it's hard to call the bottom, this is about as good a time to be acquiring assets through discount. I know it's not exactly acquiring assets, but this is a pretty good time to take advantage of opportunities on our own balance sheet and improve value significantly.

Priyanka, do you want to just respond on the specific asset?

Sure. Thanks, Richard. The only thing, Rick, that I would add to what Richard said is, if you look at from a credit migration standpoint, the last couple of quarters, it's really been focused on residential assets. And in that sector, we truly believe that there's not been a secular shift in value. It's more of a moment in time. So the ability to bring these assets onto our balance sheet, like Richard said, do a much better job managing them than the sponsors in many cases and then writing the value up as we see rates come down, cap rates come in. So we think that there's a particularly compelling opportunity at the moment.

(multiple speakers)

The delay is difficult. I would only say that we could also see borrowers surprise us and find rescue capital and pay us off as we take more aggressive action because we see the real value of these, otherwise we wouldn't be taking them. So it's not our expectation, but I think it's -- now is the time to act relatively aggressively.

Got it. Okay. And sorry, for talking over each other. I apologize for that. Look, I think the reality is that is a more consistent approach with your historic strategy. And I realize we've been through a pretty challenging period where the focus instead of optimizing outcome by managing it has been focused on liquidity, but it does seem like you're going back to what your original intent was.

That's absolutely right. I think we've tried to manage to with the expectation that rates would be higher for longer in coming -- so what we believe is the end of that rate increase cycle for certain and very likely could be a significant cut here, but it's time to pivot back to our original strategy as it relates to assets and our capacity and ability to create value, I think is going to be demonstrated over the next few quarters here.

Doug Harter, UBS.

Hi, thanks. I think you talked about working with your lenders about adjusting covenants. Can you just talk about whether there was any -- anything you had to -- any concessions you had to give to them in order to get those or just kind of how those negotiations went?

Sure, Doug. This is Mike. I'll take this one, I would say we've always had a very constructive relationship with our repo counterparties. And it's been very collaborative. And as we've looked at sort of a stable loan portfolio, we've been very much ahead of the curve in terms of workings through assets that have been demonstrating challenges, reducing leverage on those assets to be more reflective of what the current environment was looking like.

So the -- I would just -- because of that fact, I think we've been very proactive in deleveraging our balance sheet. We were very transparent with our lenders in terms of where we saw the world heading over the course of the -- over the next year or so, and demonstrated to them that having some covenant relief while we work through some of these things, including taking certain loans to REO and improving cash flow, it's not going to happen overnight, but it will happen over time.

Those -- the covenant relief that we were going to need to execute on those strategies from both an interest coverage and tangible net worth perspective was recognized, and we were able to work through those modifications.

And then just as a follow up, where do you stand with covenants on your term loan? And just how should we think about the other parts of the debt?

Sure. So term loan has a similar interest coverage covenant, but it's a different mechanic that is involved in calculating that. So we continue to comply with that interest coverage covenant on our term loan. Now that we've sort of worked through, sort of these repurchase agreement facilities, recognizing our term loan expires or matures in August of 2026 over the latter part of this year, we'll pivot into having discussions with them around modification, extension, potential paydowns necessary to extend the term of that facility, but too early to know where it's going to go just yet, but trying to stay well ahead of it before the maturity in a couple of years.

Tom Catherwood, BTIG.

Thank you and good morning, everybody. Richard, you mentioned in your remarks the expectation of lower rates and higher risk real estate values driving a real valuation of where you want to allocate capital, and you listed a number of potential options. I'd assume that that evaluation it takes time, obviously taking some more stuff on balance sheet and investing that takes time. Are there parts of those investment options that could be executed sooner rather than later as far as whether it's stock buybacks or debt buybacks and what are other ones that are more likely to be medium-term options?

Sure. Thank you. Excellent question. Some of what is in front of us, we're going to execute on rapidly because we have been expecting this market turn. We I don't want to say that we were expecting that dramatic sell-off or shot across the bow that the market is sending to the Fed. That's what it is.

But we were expecting that there was going to be a bit of change because we're seeing it in the real estate capital markets. We're seeing liquidity come back. So we were already expecting this. The move is likely to be much greater than maybe any of us had anticipated just a week ago.

So we were really set up and ready to go and kind of just getting ahead of these events. So we do think that there are things that we can execute on quite rapidly. Of course, everything is on the table and the more payoffs we get, the more likely it is that we pivot away from REO, or we will see what component of REO will be of it towards other things like new origination, paying off debt as well as buying stock.

We want them all to be on the table because the pace of repayments has been accelerating while the pace of problems has been decelerating. And so, really everything is on the table here. We just come to the point where we're ready and we've been waiting to see something that felt like a bottom to take those steps. I hope that was we're reasonably responsive.

That's very helpful, Richard. And that actually kind of ties into my next question where you're thinking about which -- maybe just one for Mike. Given the accelerated activity level around repayments, especially post 2Q, what are your expectations in terms of repayments for the balance of this year? And how are you thinking of allocating those potential proceeds between committed fundings that you have to meet this year, versus building liquidity for those more opportunistic investments that Richard mentioned?

Sure. And I think we have pretty good line of sight and pretty significant amounts of repayments all through the rest of this year and into the early part of 2025, and it's always just a capital allocation decision when we have excess capital: what are we going to do with it?

As Richard highlighted, you know, we do expect to see take assets back into REO. That is a judicial process. So there's the time considerations that you have to work through to get there. But frequently we control that timing. Obviously, there's some fairly accretive uses of that liquidity in buying back some of our higher-cost debt and paying down leverage as well as potential share buybacks from our new originations. But it's going to be a decision at that point in time, what to do with that capital.

A lot of those things sort of fit into our decision to cut the dividend this quarter. And I don't think it should be viewed solely as an indicator of where we think distributable earnings will be. We sort of looked at it more around what dividend level that we need to meet to maintain our REIT status. And given that we've paid out pretty much everything we need to pay out from a dividend perspective to maintain our REIT status, we thought it was best to keep that capital in the system and use it for purposes that would help us grow earnings or grow book value.

Understood. And then, Mike, last one for me. You had mentioned office loan repayment post 2Q. For the noncash consideration part of that, was the discounted loan a slice of the senior position or a mez position? And what were the two equity interest that came along with that repayment?

Priyanka, do you want to handle that one?

Yeah, sure. Hi, Tom. It's Priyanka. So we -- I'll take a step back real quick just to explain how we thought about that transaction. We were basically trading out of a vacant office building in Brooklyn, reducing New York City office exposure, which just going back to the earlier comment, when we think about shifts in value, what's fundamental shift versus a capital market shift and we view that, that asset exposure that we traded out of as more of a fundamental shift in value that's not likely to come back.

And we -- to answer your direct question traded into a pari mortgage piece on a cash flowing versus vacant asset with improving performance, positive trajectory in an asset class that is improving, retail has become an improving asset class. And then as we mentioned, with additional credit support on other assets that are owned by that sponsor. So we view it as a very positive trade from an asset quality standpoint and visibility to pay off for such the asset that we were in prior.

And will those equity positions shop as REO or they'll just be kind of bundled into other -- in your holdings?

Mike, do you want to take that up? It's just going to be other --

Yeah, we'll expect to recognize -- won't reflect any basis for that in our financials is the current expectation and to the extent we receive distributions, it would be cash basis. That's the expectation.

It's just got additional collateral. It's just additional credit support that's solid as it's bolstering the underlying asset.

(Operator Instructions) Jade Rahmani, KBW.

Thank you very much. What's the dollar amount of loans you expect to take into REO?

Hey, Jade, it's Priyanka. I think that's hard to put a number on it, just given that we are working with borrowers in certain instances, and it's just unclear where we're going to end up in that. But this specific sponsor where we've had a lot of credit migrations from three to four over the prior quarters that in and of itself is about 5% of our UPB. So I would say that those are likely to become REO. But that said, just depending on where we end up with other sponsors, there might be additional as well.

The 5% is beyond the Dallas multifamily?

No, that's inclusive of the Dallas multifamily.

Okay. That's somewhat helpful, turning to risk ratings, and I'm curious why do you have risk-rated four loans that you expect to take into REO? Shouldn't those be risk five?

Well, Jade, it's a function of when or not you -- Priyanka, you can handle it. Part of the question I think is more around GAAP accounting requirements, but just because a loan is expected to go to REO, doesn't mean that a specific reserve is required. There may be a specific reserve required based on foreclosure -- based on the appraisal we had on the asset prior to foreclosure. But, I think, in all of these, we feel very comfortable with the long-term collateral value that we'll be stepping into.

Priyanka, I don't know, if you want to add anything to that?

No, I think that's exactly right.

Thank you. There are no additional questions waiting at this time. I would now like to pass the conference back to management for any additional or closing remarks.

Well, I just want to thank everyone for joining us on the call today and for the questions and conclude really what was the main theme of today's call, and that is that we think the momentum is likely to continue to swing towards more repayments and more liquidity in the market. And against this background -- that's the background, which we feel confident that now is the time to be even more decisive and opportunistic with our capital. And we are kind of looking forward with optimism to a bit more of an up market and to being able to take advantage of the opportunities that are in front of us.

So thank you all for joining. I'm sure we'll have follow-up sessions with some of you, and we appreciate your questions. Thank you all.

That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.