Blackstone Mortgage Trust, Inc. (NYSE:BXMT) Q4 2022 Earnings Call Transcript

Blackstone Mortgage Trust, Inc. (NYSE:BXMT) Q4 2022 Earnings Call Transcript February 8, 2023

Operator: Good day. And welcome everyone to the Blackstone Mortgage Trust Fourth Quarter and Full Year 2022 Investor Call. At this time, all participants are in listen-only mode. I would like to advise all parties that this conference is being recorded. And with that, let me hand it over to Tim Hayes, Vice President with Shareholder Relations. Please go ahead.

Tim Hayes: Thank you. Good morning. And welcome to Blackstone Mortgage Trust fourth quarter and full year 2022 conference call. I am joined today by Katie Keenan, Chief Executive Officer; Tony Marone, Chief Financial Officer; and Austin Pena, Executive Vice President of Investments. This morning, we filed our 10-K and issued a press release with a presentation of our results, which are available on our website and have been filed with the SEC. Like to remind everyone that today’s call may include forward-looking statements, which are uncertain and outside of the company’s control. Actual results may differ materially. For a discussion of some of the risks that could affect our results, please see the Risk Factors section of our most recent 10-K.

We do not undertake any duty to update forward-looking statements. We will also refer to certain non-GAAP measures on this call and for reconciliations you should refer to the press release and our 10-K. This audio cast is copyrighted material of Blackstone Mortgage Trust and may not be duplicated without our consent. For the fourth quarter, we reported a GAAP net loss of $0.28 per share, while distributable earnings were $0.87 per share. A few weeks ago, we paid a dividend of $0.62 per share with respect to the fourth quarter. If you have any questions following today’s call, please let me know. With that, I will now turn things over to Katie.

Katie Keenan: Thanks, Tim. The snapshot of this quarter’s earnings comes down to two key numbers, $0.87 per share, our distributable earnings, an all-time record for BXMT and $0.94 per share, our net change to book value reflecting the impact of our CECL reserve increase given the more challenging credit environment. The two are integrally related. The primary factor pressuring credit performance is also driving record income for our business and that is the precipitous rise in short-term interest rates, 425 basis points over the course of 2022, the status tightening cycle in 50 years. They are also integrally related for our company, our powerful earnings stream protects the lion’s share of returns for our investors, as we work through a credit cycle.

Our dividend is delivering a nearly 10.5% current income yields, well in excess of the 3.5% impact on book value of our reserve increase. That dividend is well protected, 140% coverage this quarter, creating meaningful cushion against non-accruals. It is recurring. We paid it for 30 straight quarters. And when we out earn our dividend, the difference is retained as additional equity, further offsetting the impact of increased credit reserves on our book value. This interplay will persist, rates are still increasing and the Fed has made clear that they will stay high for some time. This will continue to pressure credit performance for the most challenged real estate assets. At the same time, elevated rates drive outsized earnings power and current return, a powerful hedge for businesses like ours.

The broader market has figured this out. After a year of massive outflows from all sectors, inflows into fixed income so far in 2023 are robust. Credit assets are inherently defensive and floating rate credit is even better today. This does not mean, we will be immune from an economic slowdown. Few businesses can be, but we believe our business is well positioned to withstand it. We start with an asset base of loans made to best-in-class borrowers with significant subordinate equity. With the benefit of insights gleaned from the far reaching Blackstone footprint, we then built up our defenses for a more difficult environment. Having seen cracks in the capital markets, we shifted BXMT to a more conservative posture at the outset of 2022. We raised the bar for our lending activities, focusing on our highest conviction themes and top tier borrowers.

We raised over $1 billion of corporate capital accumulating a deep well of liquidity. And we proactively worked with our existing borrowers to collect paydowns and recourse, reaping the benefits of our well structured loans to enhance our credit cushion, while importantly maintaining constructive relationships. At the same time, the impact of rates on carry costs, valuations and market liquidity will continue to weigh on the most vulnerable assets. This is an important concept. The impact of the current economic and interest rate environment on real estate is uneven. Income growth in multifamily, industrial and hospitality assets remains robust and supply has become more constrained due to rising construction costs, providing a longer term tailwind to fundamentals.

Capital demand is even more concentrated in these best performing assets, providing strong support to valuations. On the other hand, offices facing well known headwinds from post-COVID work patterns and the slowing economy. But here too the outcomes are uneven. The segment is not monolithic and basis and quality matter. There is scarcity in true Class A office space, as evidenced by record setting rents at trophy assets. Meanwhile, commodity office in cities that were already experiencing slowing growth prior to COVID are facing the sharpest headwinds. Our reserves are concentrated in these assets as are the bulk of our asset management efforts. The four loans with new specific reserves this quarter, date back to well before COVID, 2017 on average, on assets that where well suited to their markets at the time.

The COVID was not in the model and three of these loans are backed by office properties that are bearing the brunt of the post-COVID realignment in demand, most notably a significant reduction in government tenant office utilization. The loans also share the commonality of a material change in sponsor wherewithal towards the assets. We are sober about the value to clients impacting the most challenged of commodity office. On average, our reserves are 20% of our loan balance and imply asset value reductions of nearly 50%. But these assets are not typical of our broader office portfolio. 54% of our office loans are backed by assets that are newly built or recently substantially renovated, with an average vintage of 2021 and an average origination LTV of 60%.

34% of the office portfolio, most of the remainder, carries one or more significant credit enhancing qualities, such as particularly low leverage, high debt yield, location in high growth Sunbelt markets or material additional sponsor equity commitment in the last year. Our four and five rated office loans round out the rest and represent only 5% of the overall BXMT portfolio. A small fraction where we have meaningfully increased our reserves to account for the credit challenges we see today. Our overall loan portfolio is 97% performing. This year, we collected $3.7 billion of repayments, nearly 50% of which were on office loans. Our borrowers contributed $675 million of incremental equity, continuing to invest in their assets. We captured nearly $350 million of partial paydowns or increased recourse on 17 existing loans, primarily office, resulting in an average 16% reduction in our basis.

We were able to negotiate this deleveraging, because our loans carrying many structural protections, performance tests, cash flow sweeps, guarantees and rate cap requirements. And of course, the most important protection for a lender is leverage plan. The insulation provided by our loan basis should not be overlooked, it would take lasting declines of 30% to 40% in real estate values for us to experience a loss at our position in the capital structure and because the vast majority of our sponsors remained committed to their assets and have contributed more equity along the way, our business has been further de-risked over time, enhancing the embedded credit protection in our portfolio. In 2020, we encountered an unprecedented disruption for the real estate market.

We address that challenge much as we are addressing the delayed COVID impact on office today, actively asset managing our loans, making appropriate risk rating and reserve adjustments, negotiating for credit enhancement and providing time where appropriate. It is our job as a fundamental investor to look past the broad-brush sentiment and judiciously and proactively manage our portfolio based on Blackstone’s deep experience taking the long view and where the impacts of asset underperformance, capital markets and sponsor behavior combined to create a workout dynamic. We have the experience and the infrastructure as one of the largest owners of real estate in the world to identify and execute the best path for value preservation over time, a differentiator that will become increasingly important through the credit cycles.

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At the same time, we believe the origination environment will become still more opportunistic as values adjust and new capital is needed. We started the Blackstone Debt business in the GST and we are uniquely positioned to access the once in a cycle capital relief trades that create outsized returns on well underwritten risk. In the current market, we have found pockets of attractive regular way lending opportunities as well, exemplified by our nearly $700 million of second half originations that were 70% industrial with yields 173 basis points wider than our overall portfolio. So with transaction activity far below the norm, the addressable universe of standard new originations is smaller and to stand up to the opportunity cost of our capital, new deals today must be more attractive from both the risk and return perspective.

Most importantly, the outstanding earnings power we have been already established with our existing portfolio means, we can well afford to be patient. As we look ahead, the market outlook is mixed. We see some green shoots with the turn of the calendar. The CMBS market has reopened with AAA spreads retracing 50% to 75% from historic wides in December. The corporate debt market is active. Thanks, having cleared their stress tests are signed. Stabilizing long-term rates create support for asset values and rational long-term borrowing costs, an important dynamic that should lead to more liquid markets. But there are still headwinds, the accumulating pressure of sustained high interest rates, geopolitical uncertainty and slowing economies around the world.

As a result, we continue to position the business to withstand a more challenging period, while continuing to capitalize on the advantages that supported our performance this year. Well performing portfolio, record earnings power, substantial liquidity and a well structured balance sheet. While upcoming year may present challenges, challenge creates opportunity and there is no platform better placed to navigate this environment than Blackstone. We are the largest alternative asset manager in the world with unparalleled information experience and relationships. We have a four decade track record of performance for our investors in all market cycles. And here at BXMT we look forward to continuing to deliver for our shareholders. With that, I will turn it over to Tony.

Tony Marone: Thank you, Katie, and morning, everyone. I would like to start by unpacking our financial results for the quarter. We reported a GAAP net loss of $0.28 per share and distributable earnings or DE of $0.87 per share. DE is up $0.16 from the third quarter, driven by continued income growth from our 100% floating rate portfolio, as well as a notable prepayment fee of about $0.07 per share this quarter. Excluding this fee, our regular weighted DE of $0.80 per share is up 13% from 3Q and 21% from the equivalent metric in 4Q of last year, reflecting the significant beneficial impact of rising rates on our portfolio. We continue to see rising rates as a tailwind for our business, but 100-basis-point increase in rates from 4Q levels generating around $0.05 per share of incremental quarterly earnings all else equal.

The primary difference between our GAAP net loss and DE is the $189 million increase in our CECL reserve this quarter, primarily related to four loans with specific CECL reserves, as well as an incremental general reserve to reflect the broader market uncertainty and potential risk to our portfolio. Our aggregate asset specific CECL reserve outstands at $190 million or 20% of our five-rated loans and our general CECL reserve of $153 million represent about 55 basis points of our total portfolio, which is up from 35 basis points last quarter. While these reserves will not impact DE unless and until they are realized, we have also placed our loans with specific CECL reserves on cost recovery status effective as of 12/31. These loans received all interest payments due in the fourth quarter and generated about $0.05 per share of interest income.

However, as we collect interest payments in the first quarter of 2023 and onward, cost recovery accounting will instead apply the cash payments we receive against our basis in these loans. Ultimately should these loans fully recover, all such deferred revenue will be recognized at the time of repayments. The interim these headwind earnings will be substantially offset by the benefit of rising rates I mentioned earlier. Continuing on the topic of credit, we upgraded eight loans this quarter as performance for these assets continue to improve and downgraded eight loans inclusive of the four loans with asset specific reserves, I mentioned earlier. Our five-rated loans with specific reserves represent only 3% of our gross loan portfolio, 10% of our loans have a risk-rating of four, all of which are performing and current where we see the possibility of further stress if economic conditions worsen.

Remaining 87% of the portfolio is rated three or better. We continue to see business plans progress including outstanding performance across many of our multifamily, industrial and hospitality assets, fine, represent over half of our portfolio. We will continued to collect 100% of all interest due under all of our loans and the vast majority of our loans, 97% remain fully performing and recognizing income as usual. Although, loan repayments remained muted, we did collect $648 million of repayments this quarter, roughly in line with our $690 million of loan fundings. Turning to our capitalization, we continue to run BXMTs business with a focus on balance sheet diversification and stability. During the year, we added $3.6 billion of new credit facility capacity with our key banking relationships and we remain an important customer for them during a period when banks are increasingly selective on credit.

One of our credit facilities allow for margin calls based on market based valuation and 64% of our total financings are non-mark-to-market, either structurally immune from any form of margin call or mark-to-market provisions limited to defaulted assets only. Our liabilities are term matched to our assets and we have no material corporate debt maturities until 2026. In the fourth quarter, we strategically upsized our term loan by $325 million, effectively refinancing to $220 million convertible notes maturing in March and bringing our corporate debt raise to $1.1 billion for 2022. This incremental term loan was leverage neutral as we use the proceeds to repay revolving credit facilities. However, our reported debt to equity ratio did increase this quarter to 3.8 times from 3.6 times as of 9/30.

This is not the result of increased leverage against our assets, but rather the result of our CECL reserve, reducing the GAAP equity used in this calculation. Excluding the impact of CECL, our adjusted debt-to-equity ratio is 3.6 times, in line with 3Q and a level we generally expect to be stable going forward. Incremental capital we raised this year, as well as the incremental earnings we have been able to retain have grown our liquidity to $1.8 billion as of 12/31 or $1.6 billion net of our convertible notes maturing in March. This capital provides us with plenty of resources to manage our business during a volatile period, increase further stability in our balance sheet. Similarly we believe our $0.62 per share dividend will remain stable and is well supported by the cash flow generated by our business.

Our DE covered our dividend of 116% over the course of the year and 140% this quarter, giving us ample dividend coverage and a wide range of credit scenarios. For example, in an onerous downside scenario, where all of our five-rated loans and all of our four-rated office loans stopped paying interest, our 4Q earnings level would still cover our dividend with a healthy cushion, all else equal. Of course, we are not expecting this scenario to unfold, but it highlights the inherent resilience of our business and ability to maintain dividend stability. We look forward to continuing to deliver consistent reliable current income for our stockholders and we maintain our focus on stability and downside protection admits a more challenging environment.

With that, I will ask the Operator to open the call to questions.

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Q&A Session

Operator: Thank you. And the first question is coming from Doug Harter with Credit Suisse. Please go ahead.

Doug Harter: Thank you. Katie, hoping you could talk a little bit more about the four loans that you put reserves on kind of what specifically kind of occurred in the quarter that kind of led to that the down grade and specific reserves?

Katie Keenan: Sure. So the loans that we added specific reserves this quarter were three office loans and one very small rent stabilized multi-loan. We previously had them on the watchlist and talked about a few of them last quarter as areas of concern. They — we had the general sponsor — supportive sponsorship behavior, and as Tony mentioned, all of these loans have been paying interest. But we are in a dynamic environment and the performance of these loans have changed over time. In terms of the office loans, which are the lion’s share are in some of the most challenged markets, DC, Long Island City, Orange County. And I think also worth noting, the quality of these buildings is quite distinct from the norm in our portfolio.

They are generally more commodity buildings. We made the loans knowing that at low leverage points, because they were relevant to a specific niche of the market that has now changed materially. So the setup of these loans became more challenging in the post-COVID world and then that combined with the impact of higher rates on carry costs and liquidity combined with some upcoming maturity has created a decision point and we made the decision to move those loans to five and take the specific reserves. We are actively working on these loans to resolve them and bring them to a conclusion. And as a reminder, the loans we downgraded our only 2.4% of the overall portfolio and really represent a different paradigm than what we are seeing in the most of the portfolio.

Doug Harter: Just on the maturity point, Katie. I guess what are the — kind of the final maturities or what would be or extension dates that could kind of trigger the next decision point from the sponsors?

Katie Keenan: So I think we are already in that conversation. They have office loans have their maturities this year and so that’s really part of what is resulting in these reserves and the conversations we are having. So there isn’t another sort of impact or relevant timelines.

Doug Harter: Great. Thank you.

Operator: And our next question is coming from Don Fandetti with Wells Fargo. Please go ahead. Don, we can’t hear you. Maybe you are on mute.

Don Fandetti: Hi, Katie. Can you talk a little bit about how higher rates are pressuring borrowers and can they handle much more if the Fed continues to raise and were you able to give modifications in that type of thing to manage through that?

Katie Keenan: Sure. So I think that clearly higher rates and especially the accumulating impact of higher rates for longer create pressure for borrowers. They may carry costs more expensive. They make the option value more expensive for assets that are already challenged. They changed the perceived cap rate and certainly the higher rates and overall Fed tightening is having a very material impact on liquidity. So those impacts are happening. I think it’s important to note that even with that we still have a 97% performing portfolio. So our assets are withstanding those impacts, which we have been felt for quite a period of time now and I think that’s a testament to the equity value and the assets and our sponsors view about the long-term value of the assets, which we share.