Lument Finance Trust Q1 2024 Earnings Call Transcript

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May 10, 2024

There are 10 speakers on the call.

Operator

Good morning and thank you for joining the Lumen Finance Trust First Quarter 2024 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 Andrew Chang with Investor Relations at Lumen Investment Management. Please go ahead.

Speaker 1

Good morning, everyone, and thank you for joining our call to discuss Lumen Finance Trust's Q1 2024 Financial Results. With me on the call today are Jim Flynn, our CEO Jim Briggs, our CFO Jim Henson, our President and Zach Halpern, our Managing Director of Portfolio Management. On Thursday, May 9, we filed the 10 Q with the SEC and issued a press release to provide details on our Q1 results. We also provided a supplemental earnings presentation, which can be found on our website. Before handing the call over to Jim Flynn, would like to remind everyone that certain statements made during the course of the 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.

Speaker 1

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 statements. These results and uncertainties are discussed in the Company's filings reported with the SEC, in particular, the Risk Factors section or Form 10 ks. It is not possible to predict or identify all such risks, and listeners are cautioned not to place undue reliance on these forward looking statements. The company undertakes no obligation to update any of these forward looking statements. Further, certain non GAAP financial measures will be discussed on this conference call.

Speaker 1

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. For the Q1 of 2024, the company reported GAAP net income of $0.11 and distributable earnings of $0.15 per share of common stock respectively. In March, we also declared a dividend of $0.07 per common stock common share of stock with respect to the 1st quarter. I will now turn the call over to Jim Flynn.

Speaker 1

Please go ahead.

Speaker 2

Thank you, Andrew. Good morning, everyone. Welcome to the Lumen Finance Trust earnings call for the Q1 of 2024. We appreciate everyone joining today. Let's start just as we enter 2024, costs are fully optimistic the lending environment would begin to improve during the first half of the year.

Speaker 2

We are now in early May. The Fed has yet to implement any rate cuts and the economic data suggests inflation has remained stubbornly elevated. The economy and labor market have remained broadly resilient despite the historic increases in short term rates that began over 2 years ago. And although the Fed has indicated that it did not expect future hikes during its remarks a couple of weeks ago, the consensus view of higher for longer seems prudent until the trend in economic data suggests otherwise. The multifamily sector continued to be challenged during the Q1 with muted property sales activity leading to limited acquisition financing opportunities.

Speaker 2

Given the persistence of elevated interest rates, borrowers have also been reluctant to refinance their portfolios unless compelled to do so. Just this week, the MBA announced 1st quarter volume lending volume with multifamily down 7% year over year in Q1 and down 29% from Q4 of 2023. Despite the challenging short term environment, nearly $500,000,000,000 of multifamily mortgage debt is expected to reach initial maturity by the end of 2025 according to MDA estimates. And combined with the perhaps causing property sales transaction volume to move toward a new normal level activity, we expect to see a return of attractive lending opportunities in the medium and long term. Multifamily as an asset class continues to outperform other CRE property types and we believe this is the reason our company provides its shareholders with a unique value proposition.

Speaker 2

LFT has a deliberate focus on middle market multifamily credit, success in active asset management and strong sponsorship provided by the broader Lument and Oryx platforms. As a result, the company has been able to maintain stable dividend with better than average credit performance within its investment portfolio and a superior dividend yield relative to many of our peers. Having effectively fully deployed our investable capital in the second half of twenty twenty three, our focus this quarter was on proactively managing our portfolio to protect shareholder principal. We successfully resolved the 2.5 rated assets from our December 31 report and maintained a stable weighted average risk rating of 3.5 for the quarter ended March 31 with no specific reserves recorded during the period. We increased our available unrestricted cash quarter over quarter and in Q1 with approximately $65,000,000 compared to $51,000,000 in December as of December 31.

Speaker 2

We believe the increased liquidity will allow us to maintain flexibility in achieving positive asset management outcomes for our shareholders and provide us with the potential to deploy capital into attractive investment opportunities outside of our 2 existing securitization structures. In the meantime, we have earned relatively attractive returns on our cash deposits given the elevated short term rates. Our portfolio continues to be financed with long dated secured financing that is not subject to mark to market margin calls. SL1, the CRE CLO we closed back in 2021 is now beyond its reinvestment period and has begun to delever with repayments of its collateral. We continue to explore opportunities to refinance the portfolio.

Speaker 2

As of quarter end, the cost of funds for FL1 was sulfur plus 1.57 and an effective advance rate of approximately 82%, levels which we believe are still attractive relative to other portfolio financing alternatives available in the market. The LMS financing transaction we executed mid last year has a remaining reinvestment period that extends into July 2025 and we fully intend to reinvest capital as liquidity within that structure becomes available. With that, I'd like to turn the call over to Jim Briggs, who will provide us details on our financial results. Jim?

Speaker 3

Thanks, Jim. Good morning, everyone. Last evening, we filed our quarterly report on Form 10Q 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 4 through 7 of the presentation, you will find key updates and earnings summary for the quarter.

Speaker 3

For the Q1 of 2024, we reported net income to common stockholders of approximately $5,800,000 or $0.11 per share. We also reported distributable earnings of approximately $7,600,000 or $0.15 per share. There are a few items I'd like to highlight regarding activity during the period. Our Q1 net interest income was $13,000,000 compared to $9,100,000 in Q4 of 2023. The sequential increase was primarily driven by higher exit fee income due to greater quarter over quarter payoff activity within the portfolio and $3,000,000 related to the resolution of 2 defaulted loans, 1 collateralized by an office property located in Columbus, Ohio, in which we reduced our current value to 0 and the other collateralized by multifamily property located in Virginia Beach, Virginia, which was modified during the quarter with, among other things, previously being brought current.

Speaker 3

Payoffs during Q1 totaled $97,000,000 as compared to $43,000,000 in the prior quarter. Associated Q1 exit fees totaled approximately $825,000 as compared to $210,000 recognized in the prior quarter. The majority of loan payoffs we experienced were driven by borrowers either refinancing with another lender or selling the underlying properties. As a reminder, when one of our loans are refinanced with a permanent agency loan provided by an affiliate of our manager, The borrower exit fee is waived pursuant to the terms of our management agreement. In these instances, we do, however, receive a credit equal to 50% of the waived exit fees against our reimbursable expenses due to our manager.

Speaker 3

Our credit for waived exit fees was flat quarter on quarter. Our total operating expenses were $4,300,000 in Q1 versus $2,700,000 in Q4 of 2023. The majority of the sequential increase in expenses was driven by the accrual of incentive fees due to our manager, which are approved and payable on a quarterly basis, equal to 20% of the excess of core earnings as defined in our management agreement over an 8% per annum return threshold. Distributable earnings can be used synonymously with core earnings in this context. Outside of that, operating expenses were largely flat quarter on quarter.

Speaker 3

The primary difference between reported net income and distributable earnings to common was approximately $1,800,000 attributable to the increase in our allowance for credit losses, all with respect to our general CECL reserves. Property acquisition volume continues to remain depressed, leading to limited visibility in the market with respect to valuation and cap rates. The increase in general reserve is reflective of changes in the macroeconomic forecast, including current higher rates for longer sentiment as well as cautiousness in our modeling as it relates to CRE pricing during this period. As of March 31, we had 2 loans risk weighted 5 for default risks. 1 is a $17,000,000 loan collateralized by a multifamily property in Brooklyn, New York and risk rated 5 due to imminent maturity default.

Speaker 3

The other asset is a $20,000,000 loan collateralized by 2 multifamily properties near Augusta, Georgia that is risk weighted 5 due to monetary default. Both of these loans have been placed on non accrual status, although both of these loans have since made their April interest payments, which will be recognized in income on a cash basis. We evaluated both of these 5 rated loans individually to determine whether asset specific reserves credit losses are necessary and after analysis of the underlying collateral determine that none were necessary as of March 31. As of year end, the company's total equity was approximately $243,000,000 Total book value of common stock was approximately $183,000,000 or $3.50 per share, up from $3.46 per share as of year end. We ended the Q1 with an unrestricted cash balance of $65,000,000 and our investment capacity through our 2 secured financings was effectively fully deployed.

Speaker 3

We'll now turn the call over to Jim Henson to provide details on the company's investment activity and portfolio performance during the quarter. Jim?

Speaker 4

Thank you, Jim. I will now share a brief summary of the recent activity in our investment portfolio. During the Q1, LFT experienced $97,000,000 of loan payoffs. A portion of these loan payoffs related to the defaulted loans discussed by Jim Briggs earlier. We did not acquire or fund any new loan assets during the Q1.

Speaker 4

As of March 31, our portfolio consisted of 81 floating rate loans with an aggregate unpaid principal balance of approximately $1,300,000,000 100% of the portfolio was indexed to 1 month SOFR and 94% of the portfolio was collateralized by multifamily properties. An analysis of our net interest income sensitivity to shifts in terms over appears on Page 12 of the earnings supplement. Our investment portfolio continued to perform well during the Q1 and we ended the period with slightly more than 77% of the loans in portfolio risk rated A3 or better, marking a slight improvement versus the Q4 of 2023. Our weighted risk average rating remains stable at 3.5 sequentially. Our 5 rated aggregate loan exposure decreased to approximately 38 $1,000,000 this quarter versus $46,000,000 as of year end.

Speaker 4

At the time of our last earnings call, we had 2 5 rated loans that have now been fully resolved. As expected, we received additional insurance proceeds in the amount of $13,500,000 on the defaulted loan on the property in Columbus, Ohio, reducing the carrying value of this loan to 0 and after taking into consideration legal and other costs, resulting in the recognition of one time income of approximately $2,500,000 during the Q1. The other 5 rated asset at the end of 2023 was a defaulted loan on a multifamily property in Virginia Beach, Virginia. We entered into a loan modification with the borrower and received a $3,600,000 partial principal pay down during the Q1. Last week, the borrower repaid the remaining loan balance in full in accordance with the terms of that loan modification.

Speaker 4

We are very pleased to have achieved positive asset management outcomes for these loans, thanks to the deep experience and diligent efforts of our team. With that, I will pass it back to Jim Flynn for closing remarks and questions.

Speaker 2

Thank you, Jim. Thanks to our attendees and your interest. And operator, please open the call for questions.

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Our first question comes from the line of Kristine Love from Piper Sandler. Your line is open.

Speaker 5

Thanks. Good morning. So no new investments in the quarter, but you did have some payoffs. So can you just speak to some of the drivers that had an expectations going forward? In the quarter?

Speaker 5

Was it lack of opportunities, cautiousness in the market or anything else you would call out? And then just how would you expect new investments to compare to payoffs in coming quarters? Thanks.

Speaker 2

Thanks, Vincent. So yes, go ahead, sir. Can you repeat that? Okay.

Speaker 6

Yes. So, as noted in on the call earlier, FL1, which is our 2021 securitization is out of its 3 investment period. New investments previously were often reinvestment of that securitization. So right now, we're basically at capacity given that FL1 is out of reinvestment period and LMS, the 2023 Canadian transaction is at capacity. We do have $60 plus 1,000,000 of cash.

Speaker 6

It's just a matter of strategically looking to refinance FL1 and planning with that excess cash accordingly. There's something to consider over the next couple of quarters as FL1 continues to deleverage. But over the near term over the next quarter to 2 quarters, I don't know that we'll see FL1 refinance, but that'll all be market condition dependent.

Speaker 2

So the answer is we're effectively fully deployed with obviously the elevated cash. So in answer to your question, I would expect to be able to fill any reinvestment capacity that we have in a reasonably unless it's at the very end of the quarter, we'll be able to despite the relatively slow market, there are lending opportunities.

Speaker 5

Right. Okay. That makes sense. I appreciate that. And then second question for me, can you just give us your views on credit in the portfolio?

Speaker 5

Provision increased a bit here. Credit metrics were stable and the resolutions were good to see. But some other competitors have been having tougher experiences as of late. So anything on credit that you're seeing would be helpful. And then why you think you might be performing better than some of the peers in the space here?

Speaker 2

Well, the honest answer is I think we've done a very good job of putting together a quality portfolio. And we've had good sponsors who have worked with us to come up with resolutions to challenging situations. And we feel pretty confident and comfortable that we'll continue to be able to do that in the existing portfolio. We've had the structure of our loans have always had rate caps. We've had milestones for drawing down new capital in terms of rental increases and actual business plan milestones that have provided opportunities to work with sponsors sometimes sooner in the process than others may have been able to.

Speaker 2

In general, I think we were did a good job on the front end and have a very, very good asset management and portfolio management group that spend a lot of time at the assets and with the sponsors and making sure that we're timely on top of issues. There's not something more secret than that other than I think we have a really good credit team.

Speaker 5

Great. Thank you, Jim. Appreciate taking my questions.

Speaker 2

Thank you.

Operator

Our next question comes from the line of Jason Weaver from Jones Trading. Please go ahead.

Speaker 7

Hey, good morning. Thanks for taking my question. First of all, you spoke to this in the last question regarding the wind down of FL1. I was curious with how much credit spreads have tightened in here quarter to date and over the Q1. If the opportunity is more immediate to pursue that refinancing and where So on I mean, on the

Speaker 2

So on I mean, on the credit side, from at 82% and 157% over, there's no opportunity that's really even close to that in rather private or public. But as you point out, like as time goes by and we continue to delever, the cost of those funds will increase. You asked immediate, we're evaluating it like we have been and continue to do so, depending on how you define immediate. But we think that there's potential this year or early next year to potentially be refinance that, but it's really going to be dependent on the capital markets. Obviously, we can get its own, I think.

Speaker 2

I shouldn't say obvious, but I think you can get a refinance done in the public markets. I think there's other structures with private or non capital markets transactions that would provide for refinancing. But today, frankly, they're economically not as attractive to pull the trigger in our opinion, but we're getting closer to that. And we are working with our banking partners who have been thinking of ways we might refinance that portfolio in a way that does make sense, perhaps sooner than later. But the short answer is we feel comfortable with the financing today and want to continue to take advantage of the relative cost of capital and frankly higher leverage that we might otherwise achieve outside of or in a new deal.

Speaker 2

But it is something we're going to be continuing to do every month, look at the market, look at what we can get and compare long term what we're doing. And I'll also note, I mean, we said this, I mentioned the $500,000,000,000 of maturities coming up, we're already almost halfway through 2024. So that number is probably been pushed into 25 already with extensions. We just don't have that data in the market yet. So the opportunity is coming.

Speaker 2

We're already seeing more for sure, but it's nowhere near where it's been a couple of years ago. So that's also a consideration just in terms of taking advantage of refinancing and creating more capacity. We want to make sure that we have attractive investment opportunities at that time as well. So that's part of the equation as well. So not a direct answer, but that's our thought process and we talk about it internally and with the Board every time we meet.

Speaker 7

No, that's still very helpful. And I was also curious, is there with the liquidity build that you've seen to date and taking into your answer into account with what you're likely to see on more repayments, any change in your posture towards how you're thinking about possible share repurchases?

Speaker 2

It's something look, it's been on the table with the Board. I mean, one of the there's obviously a number of issues, right? The size of the flow being a big one. It's certainly something we consider. It's but it's weighing the benefits of liquidity, future investment capacity and the immediate kind of benefit to shareholders and how that might impact the long term value.

Speaker 7

Okay. Thank you very much for taking my questions.

Operator

Our next question comes from the line of Stephen Laws from Raymond James. Please go ahead.

Speaker 8

Hi, good morning. Nice start to the year. Good number out of the gate. I know nice to get the 2 5 rated loans resolved. Can you touch on the resolution path for the new 5 rated loans?

Speaker 8

I know you've said both paid April, no specific reserves. So good updates there. But can you talk about timing or resolution path on those 2 loans, but 3 assets?

Speaker 2

Yes, exactly. Do you want to weigh in on it? Yes.

Speaker 6

Yes. I mean, I think that is a very real time conversation. I don't think we're prepared to share the exact resolution path at present. But just like what you've seen from us in the past, this involves hands on active management negotiation with the sponsors push towards quick resolutions.

Speaker 8

Okay. And then to circle back to the CLOs, I guess, or FL1 specifically, Looking at Q4, that spread was $155,000,000 and only increased even with $70,000,000 some odd of repays to $157,000,000 Is it can you help me with the math there? How I think about that going forward? Is it a pro rata pay structure in some way? Or I was a little surprised with that level of prepays that that financing cost didn't increase by more than 2 basis points sequentially.

Speaker 6

Yes. I mean what I'd say is that the 2021 seconduritizations with the big AAA and then pretty flat spreads down the stack, meaning that this isn't a 600 basis point BBB spread. We don't have exactly offhand where the BBB is, but I want to say it's in the 300s. You're only seeing a marginal increase in spread from that AAA paying down. It is the AAA paying down.

Speaker 6

It's not the pro rata of the other tranches. It's just mechanically what the number is. It will shift up as the AAA continues to pay down, but not excessively. Frankly, the larger issue there is just the deleveraging, right? The fact that you have less debt on your equity.

Speaker 6

And that will be the primary driver of the need to refinance ultimately.

Speaker 8

Okay. Appreciate that. Yes.

Speaker 2

And its size, it's a bigger excuritization than the other ones. So that's very small. It will. It's small.

Speaker 8

It's the BBB. The BBBs that tied, it probably stays pretty attractive for some time. I guess to think about incorporating other financing structures you mentioned, I mean, would you look at bank lines and along those lines, where are spreads on new investments for what you see as you look at opportunities? And how do those spreads compare with what bank lines banks are charging these days. If you were to go that route and kind of considering the lower advance rate on those facilities, what would a fully levered ROE look like if you chose a path like that to open up the growth opportunity?

Speaker 2

Well, I think there's 2 questions there or 2 answers. 1 is the refinancing of the if we were to refinance FL1 with a turned out bank line, just I think how you're asking, That spread and that leverage would be negotiated and I don't think it would certainly be related and correlated to a market, but it wouldn't be the same as a new warehouse. Those spreads so new asset spreads are there's a wide range because the credit is a wide range. You have high quality new construction deals that are coming out of construction into lease up at relatively low leverage pricing in the mid to high 200s, low 300s depending on where and what you have extended business plans for bridge loans that have taken longer and are maybe getting recapped with the new sponsor, same sponsor for an extra couple of years that are probably more in the 300s. And then you probably have some and then you could go into the maybe higher leverage, different markets above that, which we're not typically see too much.

Speaker 2

But those are so the asset spreads is we're trying to balance some of the credit risk versus the return obviously as we've done. So we'll have a balance of those opportunities. And I think warehouse and bank spreads when you're thinking about what those look like in the market, which we don't have LSP, but the sponsor obviously we do. Those credit spreads and leverage relate to the assets I just said. So you have, let's say, in the high 100s to the low 200s for new deals, newly originated deals and leverage 70%, 75% is pretty market, I would say.

Speaker 2

Zach or Andrew or anyone, if you guys have more to add there, but I think that's about where things are. Yes, that's fine.

Speaker 1

Yes. Well, that's great color and

Speaker 8

I really appreciate you walking through those numbers for me. Appreciate it. Thanks for the comments this morning.

Operator

Our next question comes from the line of Christopher Nolan from Ladenburg Balmain. Please go ahead.

Speaker 4

Thanks for taking my questions. The Brooklyn non accrual, is that a rent stabilized building?

Speaker 2

Zach, you have the exact answer. I'm sure there's some. I don't I'd have to check on it.

Speaker 6

Yes. Right. It's primarily market rate.

Speaker 2

Okay. To be clear on that field, there's no yes, there's just I mean, I'll state unequivocally that that is not an issue. This is value is not an issue

Speaker 6

on that one. We'll say that.

Speaker 4

Okay. And then, for the loan portfolio in general, do you have any interest only loans?

Speaker 2

Well, they're all Yes. I mean, for the floating rate stuff, it's all interest only, which is the portfolio. I mean the bridge portfolio is interest only. There are rebalancing requirements that would require principal pay downs and those exist in all forms.

Speaker 4

Okay. And then in final

Speaker 2

question Yes, just a recap

Speaker 6

of what these underlying bridge loans are. They're typically either 2 or 3 year terms, the floating rate and interest only, they do have interest rate apps, which are purchased by the sponsors. But Bridge is primarily whether it's us or competitors in the space, they are interest only with.

Speaker 4

And I guess given that, how does that affect your reserving methodology just because these borrowers sort of have a larger balloon payment at the end than normally?

Speaker 2

So, I mean, I'll let Jim and Greg speak to the process. But just in general, I mean, so when we look at our when we do an active by asset analysis of our portfolio, from my perspective and there's actual process, but the key metric we're looking at to start is what's our basis, our loan to value. And so that's the primary driver. Whether in some cases, we obviously have assets that maybe started at 70 as is LTV and might be 75 or 80 today and that's not the equity has lost value, but our credit position is pretty good. So that's where we're kind of evaluating and then obviously looking at the market and the comps.

Speaker 2

So we're doing a true asset by asset analysis on whether we think there's an impairment or risk of loss. On the general reserves, on the CECL side, that is a more macro market driven analysis and that is less focused on the specifics of our portfolio and more focused industry and macro trends. And Jim, I don't know if we've generally taken, we think, a fair

Speaker 5

Yes. I mean,

Speaker 3

it's going to be a combination of both. CECL requires a look forward on what the macro environment and the forecast is going to be. We choose a 1 year period for that. But to Jim's point on collateral value and LTVs, that is a big driver as well. And you're seeing that in our general reserve rate.

Speaker 3

I talked about our general cautiousness in this period as we model where there's not a lot of activity getting done and the observability of cap rates and valuation, that's sort of speaking to LTVs, right, and collateral value. So the same drivers that Jen talks about is going to be a big driver of the reserve. There is going to be this macro economic look as well because it's expected losses over the life and we need to be forecasting. And we saw that macro for us that macro forecast move to a more of we're not going to see rate cuts as soon as we thought we were going to and they're going to come later in the year potentially. So it's a combination of both, but I would say that LTV is going to be a driver there and was a driver of the reserve.

Speaker 2

Okay. Thank you.

Operator

Our next question comes from the line of Rod Blom from UBS. Please go ahead.

Speaker 9

Good morning. Good report. The recoveries on the commercial building, I guess, to me sort of look like an extraordinary gain. If we strip out that gain, what do distributable income per share numbers look like?

Speaker 3

More those one timers work out to be about $0.06 for the one timers. And I spoke about the incentive fee, so that's sort of going the other way for about $0.03

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Lument Finance Trust Q1 2024
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