BrightSpire Capital, Inc. (NYSE:BRSP) Q2 2023 Earnings Call Transcript

BrightSpire Capital, Inc. (NYSE:BRSP) Q2 2023 Earnings Call Transcript August 2, 2023

BrightSpire Capital, Inc. misses on earnings expectations. Reported EPS is $0.22 EPS, expectations were $0.24.

Operator: Greetings, and welcome to the BrightSpire Capital, Inc. Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. And it is now my pleasure to introduce to you David Palame, General Counsel. Thank you, David, you may begin.

David Palame: Good morning, and welcome to BrightSpire Capital’s Second Quarter 2023 Earnings Conference Call. We will refer to BrightSpire Capital as BrightSpire BRSP or the company throughout this call. Speaking on the call today are the company’s Chief Executive Officer, Mike Mazzei; President and Chief Operating Officer, Andy Witt; and Chief Financial Officer, Frank Saracino. Before I hand the call over, please note that on this call, certain information presented contains forward-looking statements. These statements, which are based on management’s current expectations, are subject to risks, uncertainties and assumptions. Potential risks and uncertainties could cause the company’s business and financial results to differ materially.

For a discussion of risks that could affect our results, please see the Risk Factors section of our most recent 10-K and other risk factors and forward-looking statements in the company’s current and periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, August 2, 2023, and the company does not intend and undertakes no duty to update for future events or circumstances. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company’s earnings release and supplemental presentation, which was released this morning and is available on the company’s website, presents reconciliations to the appropriate GAAP measures and an explanation of why the company believes such non-GAAP financial measures are useful to investors.

Before I turn the call over to Mike, I will provide a brief recap on our results. The company reported second quarter 2023 GAAP net loss attributable to common stockholders of $7.5 million or $0.06 per share. In addition, the company reported second quarter 2023 distributable earnings of $21.1 million or $0.16 per share and adjusted distributable earnings of $32 million or $0.25 per share. The company also reported GAAP net book value of $10.16 per share and undepreciated book value of $11.53 per share as of June 30, 2023. With that, I would now like to turn the call over to Mike.

Michael Mazzei: Thank you, David. Welcome to our second quarter earnings call, and thank you for joining us this morning. As David mentioned, we are pleased to report adjusted distributable earnings of $0.25 per share, while our dividend coverage continues to remain strong. Current liquidity as of today stands at $347 million, of which $182 million is unrestricted cash. During the quarter, we again reduced our overall leverage to 1.9x. This quarter, we recorded a $0.21 reduction in undepreciated book value, which currently stands at $11.53. This reduction was primarily driven by a net increase in our general CECL reserves in addition to a specific reserve on one office loan, which was already on our watchlist. Andy will provide more details in his section.

As everyone is well aware, throughout the first half of 2023, unprecedented market conditions have pressured commercial real estate borrowers across the board regardless of property type. These strands are unlikely to ease until the Fed begins reducing short-term interest rates, which is now expected to occur sometime in 2024. With another interest rate hike just last week, the Fed is very near the end. However, given the current strong economy, the Fed will maintain a higher for longer interest rate policy while continuing to reduce its balance sheet. This remains the primary risk factor for the commercial real estate markets over the next 12 months. Regarding our portfolio, the overall performance of our underlying office properties during the quarter has remained steady.

We have, in fact, upgraded the risk ratings for 2 office loans and we moved them from our watchlist. This is the result of these borrowers making significant progress in their leasing plans. Given the increased focus on this property segment and in an effort to provide investors more information, we have included, in our second quarter supplement package, a description of our 5 largest office loans, which represents 35% of our office loan portfolio. Multifamily, which represents 52% of the portfolio, has remained resilient. We have experienced top line rent increases across the portfolio, which have exceeded our underwriting projections. However, all property types, including multifamily, have not been immune from the rapid rise in inflation and corresponding interest rate increases.

In some cases, the positive impact of higher rental rates is being muted by rising operating expenses such as utilities, payroll and insurance. Additionally, in some select instances, we have seen increases in bad debt, primarily due to legacy tenant-friendly COVID policies in certain jurisdictions. Ultimately, we expect these conditions will improve in the coming quarters as we work with these borrowers to execute their value-add business plans. In the meantime, this quarter, we have identified and downgraded 3 multifamily loans from a 3 to a 4 to reflect specific circumstances of the property and/or the sponsor level. Importantly, all 3 of these loans as well as the entire Multifamily book are current in debt service payments. As we look at the second half of the year, our focus remains on managing our portfolio while maintaining sufficient liquidity and lower leverage.

We are, of course, eager to get back on offense and make new investments, especially as we expect many regional banks to shrink their balance sheets in the coming year. Last week’s merger of 2 West Coast banks is a great example of this. This pullback by regional banks should create ample opportunities for private credit and nonbank lenders like BrightSpire. However, in the near term, protecting the balance sheet continues to remain job #1. With that, I would now like to turn the call over to our President, Andy Witt. Andy?

Andrew Witt: Thank you, Mike, and good morning, everyone. Throughout the second quarter, the BrightSpire team has remained focused on asset and portfolio management. We believe the combination of our vertically integrated and internally managed platform, including our rated special servicer, uniquely positions BrightSpire to navigate the current environment. None of our loan asset management functions are delegated to third parties. During the second quarter, we received $162 million in repayments across 2 investments in line with expectation. Included in the repayments for this quarter was the Berkeley Hotel loan for $148 million. Year-to-date, we have received approximately $263 million in loan repayments. And as previously highlighted, we expect loan repayment activity to remain relatively low for the remainder of this year.

Our second quarter supplement now includes additional information on all our risk rated 4 and 5 loans or our watchlist loans. Our watchlist office loans were relatively consistent with what we reported to you in the first quarter. One office loan was added to our watchlist this quarter. And as Mike mentioned, 2 office loans were upgraded and removed from the watchlist. During the second quarter, we executed deed-in-lieu on 2 Long Island City loans in cooperation with our borrower and have taken full control of both office properties. We have engaged with a third-party property manager. Taking control of the properties has signaled to the market that ownership is now stable and well capitalized. This has resulted in renewed leasing interest, and we have already received unsolicited inquiries from prospective tenants.

We believe the reset basis in these properties will allow us, as owner, to better compete for tenants and ultimately stabilize and exit the properties. In terms of updates, on the Washington, D.C. office loan, we anticipate taking control of the asset over the next few months, after which we anticipate commencing a marketing process for the property. During the second quarter, we placed the Oakland office loan on nonaccrual, increased the risk rating from a 4 to a 5 and recorded an $11 million specific CECL reserve. Additionally, subsequent to quarter end, we executed on a deed-in-lieu and have taken ownership of the property. Lastly, we continue to monitor the Oregon Office Park senior loan and have provided a detailed disclosure on these investments and others in our MD&A contained within the Q2 2023 Form 10-Q.

With respect to the San Jose hotel property. Last quarter, we noted that a sales process was underway for the hotel Annex tower comprised of 264 rooms. During the quarter, a buyer was selected and terms have been agreed to. The borrower anticipates the sale and corresponding pay down of our loan to occur in the third quarter. The loan remains risk rated 4. As of June 30, 2023, excluding cash and net assets on the balance sheet, the loan portfolio is comprised of 96 investments with an aggregate carrying value of $3.2 billion and the net book value of $917 million or 81% of the total investment portfolio. The average loan size is $33 million. Our weighted average risk rating is 3.1 and the loan portfolio has minimal future funding obligations, which stands at $226 million or 7% of outstanding commitments.

First mortgage loans constitute 97% of our loan portfolio, of which 100% are floating rate and all of which have interest rate caps. The multifamily portion of our portfolio consists of 56 loans representing 52% of the loan portfolio or $1.7 billion of aggregate gross book value. Office comprises 32% of the loan portfolio consisting of $1 billion of aggregate gross book value across 31 loans with an average loan balance of $33 million. The remainder of our portfolio is comprised of 9% hospitality with industrial and mixed-use collateral making up the remainder. With that, I will turn the call over to Frank Saracino, our Chief Financial Officer, to elaborate on the second quarter results. Frank?

Frank Saracino: Thank you, Andy, and good morning, everyone. Before discussing our second quarter results, I want to mention that we expect to file our Form 10-Q later today. Our second quarter 2023 supplemental financial report is also available on the Investor Relations section of our website. For the second quarter, we reported adjusted distributable earnings of $32 million or $0.25 per share. Second quarter distributable earnings was $21.1 million or $0.16 per share. Distributable earnings includes an $11 million specific reserve on 1 loan. Additionally, for the second quarter, we reported total company GAAP net loss attributable to common stockholders of $7.5 million or $0.06 per share. The GAAP net loss reflects $29 million of total loan loss reserves, consisting of the $11 million specific reserve and $18 million of general loan reserves.

Quarter-over-quarter, total company GAAP net book value decreased from $10.41 per share to $10.15 per share. Undepreciated book value also decreased from $11.74 per share to $11.53 per share. The decline is primarily driven by increases in our CECL reserves, partly offset by adjusted distributable earnings in excess of dividends declared. I would like to quickly bridge the second quarter adjusted distributable earnings of $0.25 versus the $0.27 recorded in the first quarter. The change is driven by loan repayments, loans placed on nonaccrual during the quarter and lower onetime loan modification income, offset by the impact of rising interest rates. Heading into 3Q, our adjusted distributable earnings quarterly run rate should remain around current levels.

Turning to our dividend. For the second quarter, we declared a dividend of $0.20 per share, in line with the first quarter. Our dividend remains well covered at 1.25x. Looking at reserves and risk ranking. As Andy mentioned in his comments, during the second quarter, we took ownership of the 2 Long Island City office properties and placed the Oakland office loan on nonaccrual and recorded a specific reserve. This resulted in our second quarter specific CECL reserves decreasing by $57 million to $55 million. Our general CECL provision stands at $52 million, an increase of $18 million from the prior quarter. This increase in general CECL was primarily driven by economic conditions as well as specific inputs on certain office and multifamily properties.

The combination of asset specific and general CECL reserves at second quarter end was $107.5 million or 312 basis points on loan commitment. As a reminder, these are point-in-time assessments that we evaluate each quarter. Looking at changes in risk rankings during the quarter. Our review resulted in 4 loans moving to our watchlist, comprising 3 multifamily loans and 1 office loan. We upgraded 5 loans during the quarter to a risk ranking of 3 and removed them from our watchlist. As Mike mentioned, 2 of them were office loans on properties located in San Francisco, California; and Baltimore, Maryland. The other 3 upgrades included the Milpitas mezz A, 1 hotel mezzanine loan and a construction loan. Altogether, our average loan portfolio risk ranking at the end of the second quarter was 3.1 compared to the first quarter’s average of 3.2. Our 3 risk ranked 5 loans represent approximately 1% of the total loan portfolio carrying value, 7 loans equating to 14% of the total loan portfolio carrying value are risk ranked 4.

While all risk ranked 4 loans are current performing loans, we are seeing potential for increased risk and accordingly, are closely monitoring these investments and working with sponsors to ensure the best possible outcomes. Moving to our balance sheet. Our total at share undepreciated assets stood at approximately $4.5 billion as of June 30, 2023. Our corporate leverage levels remain at the low end of the sector. Our debt-to-assets ratio is 63% and our debt-to-equity ratio was 1.9x, down quarter-over-quarter. This concludes our prepared remarks. And with that, let’s open it up for questions. Operator?

Q&A Session

Operator: [Operator Instructions]. And the first question comes from the line of Sarah Barcomb with BTIG.

Sarah Barcomb: I was hoping if you could speak to how you think about giving loan modifications and extensions to help sponsors get to the other side of this rate hike cycle versus just removing those assets from the books, realizing a loss there, but getting some capital back now to allocate elsewhere. How do you think about that generally?

Michael Mazzei: It’s Mike. I’ll start off with that, and I’ll let Andy interject as well. I mean generally, we have a bias towards working with our borrowers. Where we feel like there is equity to protect, borrowers should step up and do something to help cover shortfalls. That could be either some pay down of the loan. We’ve experienced that. Buying the interest rate cap, which these days is expensive and some of the borrowers have definitely stepped up to do that as well as covering interest rate shortfalls and building up the reserves. Sometimes they ask us for lowering the hurdles for the extension. The borrowers have a view, “Hey, if we’re putting money into the deal today, we’d like to make sure that we’re not — we have an option of getting it out and that you don’t keep the hurdles for the next extension so high.” So generally speaking, we have a bias toward working with our borrowers in this environment.

And in many cases, all borrowers have stepped up, have made capital calls to their LPs and have funded some shortfalls there. Andy, any additional thoughts on that?

Andrew Witt: No, Mike, I think you covered it. Really, at the end of the day, we’re looking for a commitment from the sponsor of the borrower in the form of financial commitment or operational commitment. And with that, we’re generally able to figure out a path forward. And so that’s certainly path #1. The alternative path is, as you outlined, Sarah, taking the asset back and subsequently addressing any issues with the asset and ultimately moving it off of our balance sheet.

Sarah Barcomb: Okay. I appreciate those comments. And as a follow-up, I was hoping you could talk about the extent to which you used cash to buy loans out of CLOs during Q2? And were any of those loans watchlisted? And could you just generally talk about liquidity needs coming from BrightSpire on loans that you’re looking to delever in the coming months just given the expectations that you spoke to during the prepared remarks for lower repayments this year?

Michael Mazzei: Okay. On that question about buying out of the CLO, we have Matt Heslin with us who runs our capital markets. Matt, why don’t you give an update on what we did this quarter on the CLOs?

Matthew Heslin: Sure. So thanks. In Q2, we bought out two loans from our 2019 CLO. One of those was in exchange, the other one was a cash purchase. So total loan balance that was removed was about $98 million. Total cash that was used to purchase those two out was about $77 million.

Michael Mazzei: So the CLOs, even though were past the reinvestment period, there are — there is a criteria in the CLO where you can make a potential substitution for a loan. And so one of the loans that came out, we were able to substitute another loan in, which helped the liquidity there. Going forward, Sarah, it’s managing that liquidity around any potential defaults in the CLO. We have to buy out a loan or any potential buyouts on warehouse clients that we’re watching, we’re watching very closely. And I think we try to articulate that in our watchlist policy. We have — and we’ve said this on earlier calls, I think I’ve addressed this question with you before. The policy we have is we really want to avoid surprises and that really is a loan going from a 3 to a 5 where it’s nonaccrual.

And so we have a bias toward moving loans into the watchlist on a 4 basis. All the loans that we moved on to the watchlist for this quarter are current loans, and we can work through those issues with those borrowers and like the loans that were upgraded off the watchlist this quarter, we can see the same happen there, but we have a bias towards putting the loans on the watchlist so that if something does go awry that investors and analysts, such as yourself, have been given a heads up. Along those lines, we think that with the Oregon loan, which is a 4, we’re in dialogue with that borrower right now. And I think that there is a decent shot that, that loan does move to a 5 in the next quarter. And then with regard to other loans that are on the watchlist, as I said, the new loans that went on are all current.

And glancing at it now, all the loans on — in risk 4 are our current loans. We are working very closely with the borrower on the San Jose hotel. That loan is current. And then the disclosures in the MD&A this quarter, we described how the mezzanine was — there is a mezzanine class behind us. That mezzanine class was upsized by about $4 million to make future debt service payments as the hotel tries to reach stabilization. We mentioned in the prepared remarks that despite the fact that a part of that hotel is under contract for sale that could affect the credit positively, we’re keeping it as a risk rated 4, until that transaction is consummated. We think that is a September or October potential close. And from what we understand, the owner may be in the market inquiring about potential for the sale of the entire hotel.

So if that were to occur sometime in Q4 or early Q1, you could see the biggest loan on our watchlist 4 move. But we’re watching that very closely. The hotel has not yet stabilized. We’re very happy with the new flag in place and that the mezzanine is protecting and that will be a big move for us in terms of liquidity because that loan, as we’ve said on previous calls is, I think, only levered about under 50%. I think it’s like 47% leverage. So we have a lot of liquidity tied up in that loan. So a sale of that one tower and potentially the sale of the entire hotel would have a huge benefit for us liquidity-wise.

Operator: And the next question comes from the line of Stephen Laws with Raymond James.

Stephen Laws: Appreciate all the details on each of these assets. Andy, I wanted to follow up on 2 that you mentioned. First, on the Long Island City office, you talked about the initial interest you’re seeing now that you guys are in control. Can you talk about a timeline there? Kind of when you look to stabilize and sell the asset, kind of what metrics are you looking to achieve for stabilization?

Michael Mazzei: You know what, let me lead off with that. I’m going to lead off with that, Steve, because I’m very proximate to that day-to-day. That — there is one building that Andy was mentioning that we had leasing inquiry on, that was the Paragon building. That building is unique. I don’t mean to say that our buildings are better than New York office buildings. We know what’s going on in the office market. But that building is unique because it sits right on top of a subway station and a rail station and a block away from a major subway line. So we’ve gotten a lot of inquiry on that. What we’re finding is that when you do a short sell process, you’re attracting low bids because they sense — the buyer sense distress and rightfully so, I don’t begrudge them that.

So we felt like taking these assets over to demonstrate that they’re in stable hands, and more importantly, that leasing brokers are going to get paid. And that’s key. So now that we own these properties, we are getting inquire on that. I think for an exit on that, we’d have to start to see some level of stabilization, some leasing activity where if we have LOIs in place that are strong and we have maybe tenant improvement program for that tenant up and running where a buyer or a prospective buyer can see that the property could at least sustain its operating expenses and the negative carry on that is less. I also think, we said this in the prepared remarks, this higher for longer is affecting everything, this rate environment. So if you get to a point where the Fed is telegraphing lower rates, buyers can see a potential lower cost of capital.

We get some leasing traction there. I think then we would — we really want to move the asset. We don’t want to hold an asset until it’s fully occupied and stabilized. We really prefer to get the liquidity back. So it will be like a crossover point where we think we can get the maximum value for where the state of the asset is. But we are very pleased that now that we own the asset and have a third-party manager in that we are getting incoming phone calls. But I do think it will take at least a couple of quarters or several quarters for that to shift this way through.

Stephen Laws: Great. And then similar on Oakland asset was already deed-in-lieu in Q3. Is that one you looking to sell quickly or is that one that will go through a similar process?

Michael Mazzei: We hired a third-party manager. That asset is an older asset. We’re very glad that it is a low balance asset. That’s the silver lining on this. I don’t have positive things to telegraph at this point in time, given that we just got control of the asset. I do think there needs to be some CapEx that goes into the asset that the owner neglected doing for obvious reasons, knowing that the asset was changing hands. So nothing really to report on that at this point.

Stephen Laws: Okay. Great. And lastly, any update on the Norway asset?

Michael Mazzei: No. No update there.

Operator: And the next one comes from Matthew Howlett with B. Riley Securities.

Matthew Howlett: First, I mean, congrats on continuing to delever and focus on liquidity. Just any update with the bank lending group and the dialogue? Is it still [indiscernible] and obviously a lot of availability under it. Just any update on the dialogue with the banks?

Michael Mazzei: Yes. Matt, do you want to address that?

Matthew Heslin: Yes. I mean, obviously, we’ve been working with our banking partners for a number of years here. Dialogue is very positive. As Mike mentioned, we’ve been working through some amendments, which involve sponsors putting cash in and buying new caps. So we obviously work very closely with our banking partners on all of those changes, assuming those loans are on the repo lines and they’ve been extremely supportive and in line, having a very similar view to what we have on those deals where seeing sponsors contribute equity and really step up and support the assets allows us to continue to finance them and the banks continue to finance us. So we’re very aligned and conversations have been very positive to date.

Michael Mazzei: Yes, they’ve been very constructive. They’ve been very constructive and supportive. And I could probably — that’s probably the case with most of our peer group. And as long as you’re giving them total transparency and they feel like you’ve got credibility with them, which is primary with us, we’re getting that support from them.

Matthew Howlett: That’s great to hear. And I know you got a lot of availability in low lines, and it’s great to hear that they’re working with you guys on some of the — on the portfolio. Second question…

Michael Mazzei: Yes. One thing about that, Matt. Let me just add 1 thing about that is that when we project liquidity, we talk about cash, and we really think that there needs to be a distinction between — and some of our peer group are doing a good job at making this characterization. There’s a distinction between availability and your reinvestment on CLOs. Some of our peer groups state that they have liquidity because they have assets that are under levered, but they have preapproval to increase that leverage. We view that as liquidity. But just saying that we have capacity on our warehouse line, we have capacity for $800 million on our warehouse lines. We do not telegraph that as liquidity. We believe liquidity is cash on the balance sheet, in-place, unused capacity on a revolver or untapped capacity on a warehouse line that’s preapproved.

So right now, we do have capacity to lend. We have $800 million of capacity in our warehouse lines that will tap with our available cash as the haircut if we go on offense anytime soon.

Matthew Howlett: Yes, I’m glad you pointed out. You almost had double — you almost double the line, and that’s availability to do a lot of interesting things when you’re ready to go on offense. So it’s great to hear. I figured I ask that question because they have been very supportive with you guys, and it’s great to hear they are standing by you. Second question, Mike, on the triple net lease property in Norway, any headway on getting the — is the state pension fund that’s trying to — that you’re trying to get to renew and eventually refinance that debt?

Michael Mazzei: No, the status of that has not changed. The tenant, which is the state oil company of Norway has until 2030 on that lease. As we say in the disclosures, the debt matures in 2025. We have the lease payments hedged. We were able to put on a 3-year hedge when we did it in 2021, that goes to May of 2024. But until we engage with that tenant to get a possible extension, the status quo has not changed.

Matthew Howlett: Can I ask if you’ve approached them with maybe offering — if you extend early, you give them a discount and that way you get the debt refinanced, maybe even sell the property? I mean — does that make — is that a strategy that you’re looking at?

Michael Mazzei: I’ve been to Norway. We’ve had face-to-face meetings, and I would say all of the above were put on the table. They have the benefit of being the state oil company of Norway. So they have a process that they go through, and we have to observe that process in terms of how they assess their real estate needs. We are in contact with them as frequently as we can be. We were told that they may have a decision in June. That’s been postponed until September. So we are waiting for that. And again, if they’ll invite us to go to Norway, we’d be more than glad to go. But all those options are on the table, absolutely.

Matthew Howlett: Great. And then just last question. I mean any green shoots — I mean, the rates are up obviously here again today. Any green shoots and just the general CRE market and transactions. I mean some of the REIT stocks have been rallying back up, you know the headlines have been horrendous, but is it over — it could be overdone. I mean any green shoots you’re seeing, Mike?

Michael Mazzei: All right. So generally, I’d say we would trade earnings on an EPS basis that have been there because rates are up, we would trade that for a better credit any day. So we’re looking forward to rates coming lower because we think, as I said in the prepared remarks, that’s causing distress and is probably the #1 risk factor across real estate regardless of property type. Office has its own idiosyncratic issues that are big. I don’t mean to understate them, but higher interest rates are affecting every asset class in credit, particularly office. The green shoots are the — as I said in the prepared remarks, the retrenchment of the regional banks. There are probably — there are over 100 regional banks and probably something like several thousand to 4,000 community banks out there.

I think we were all somewhat surprised to see the amount of commercial real estate being done there because it’s spread out so far among all these banks, it’s very hard to detect unless you’re an expert in following that market. So we’re seeing that retrenchment occur. And we think that’s a positive for all the nonbanks and the credit funds. They are far more community banks and regional banks than there are commercial mortgage REITs and debt funds. So we think that, that will be a huge green shoot for us, and we are seeing inquiry on our origination team to try to fill that void. We’re not ready to step in yet. We want to maintain a certain amount of liquidity, but we are seeing some interesting transactions. We haven’t executed on any of them yet, as I said, but we think that’s the big green shoot in the market.

The retrenchment of the banks is going to be a huge positive. But first thing we want to see is we want to see the Fed start to telegraph a pullback in rates.

Operator: And the next question comes from the line of Steve Delaney with JMP Securities.

Steven Delaney: Frank, in your remarks, I wrote in my notes that you said there were 3 risk rated risk ranked 5 loans. When I’m looking at Page 14, I see the 2 5-rated office loans, D.C. and Oakland, but I don’t see a third 5-rated loan. Did I just hear that wrong?

Frank Saracino: No, there are three loans. You may recall last quarter, we reported on a property in Milpitas that was split into a mezzanine A and a mezzanine B, and we took a full reserve on the mezzanine B and that remains a risk ranked 5 loan.

Steven Delaney: Okay. It’s just not — it’s just not in the deck. Is that what you’re saying?

Michael Mazzei: Yes. That’s right. It’s not in there. It’s written off and…

Frank Saracino: Yes, that’s right. That’s correct.

Steven Delaney: Okay. The exposure is off. Okay. Okay. Got you. That’s helpful clarity. And then what were the issues? I noticed and Mike referred to this that you had 3, I believe, multifamily loans that you took to 4 and they’re now on the watchlist. Is there any common theme there into what was going on with those properties and the operators that caused you to push those 3 multifamilies to a 4? It looks like they’re all out West somewhere. I don’t know if that’s a common theme.

Michael Mazzei: Yes. All those loans are current. Andy, do you want to answer this?

Andrew Witt: Sure, Mike. So there — these are all loans in different and distinct markets with — in certain respects, different things going on. But I would say, generally, across multifamily, which were — our portfolio has about 52% exposure to, the asset class is performing rather well. But what we are seeing is an uptick in the expense side. So G&A is up. And then if you look at certain markets, property tax, insurance and even down at the municipality level, utilities can be up. So there have been challenges. And then additionally, as Mike highlighted in his prepared remarks, there has been in certain properties an increase in bad debt as a result of COVID kind of lenient policy. And so that’s gotten in the way of the borrowers’ ability in certain cases to clear out bad debt to take possession of certain units and make the improvements and execute on their business plan.

So that essentially is elongating the period of negative cash flow. And so we looked at these 4 investments and felt like they were behind business plan. And as evidenced in this quarter’s risk ranking movements, we’ve seen positive movement in certain assets. So that could certainly be the case here. But as Mike highlighted, we want to be upfront with these potential issues and make sure there are no surprises. So those are kind of the general themes.

Steven Delaney: Yes, that’s great color.

Andrew Witt: Steve, I will add that what we are seeing is we are seeing good rent growth. So on the top line, despite some of the headlines in our portfolio kind of on a same-store basis, we’ve seen year-over-year about a 6% increase. And so that’s taking out the units that have been renovated. Those are obviously receiving much higher premiums. So we are continuing to see good rent growth.

Steven Delaney: Got it. That’s helpful. Yes, it doesn’t — it sounds like being an apartment rental manager is a lot more challenging these days than it may have been in the past. So — and we certainly understand with the COVID changes. Good job.

Operator: [Operator Instructions]. Our next question comes from the line of Matthew Erdner with JonesTrading.

Matthew Erdner: So with the expectation that the San Jose hotel loan pays off next quarter, say that goes through, would you be willing to originate at some of these higher yields to boost the overall coupon of the portfolio and kind of jump back into the market, test the waters and start originations again? And if so, do you guys have a current pipeline that you’re looking at in areas that you’d want to target?

Michael Mazzei: Thank you for the question. I just want to clarify that on that San Jose hotel asset, there is under contract 1 tower. There are 2 towers of the hotel. The second tower was built subsequent to the first. That tower is under a PSA for sale, that has been since the spring, and that buyer really not — it’s a nonfinancial buyer. That buyer is — we’re expecting that to close sometime, as I said, in September-October. So that — the proceeds from that sale would go down — would pay down the first mortgage. We do believe that the buyer — the owner is exploring sales options for the entire hotel, but we can’t really speak to that at this point. We think that they’re making that inquiry, but we don’t have any details to report, that’s very early.

We can’t say that will occur. Having said that, any delevering that we would have in that hotel would produce liquidity because we have such a low advance rate on it. So I just want to be clear on that. And the answer is, I think to get back on offense, what we are really looking out are 2 things, not just that, but we’re really looking at our overall liquidity and the portfolio needs. So as we get, over the next quarter or 2, more visibility as to what liquidity we need to protect the portfolio, that will be the #1 sign that we have for getting back into the market. That timing probably also occurs with the Fed starting to say that they’re going to — or they can see easing going forward. So as we get toward the end of the year, we think that the prospects of playing on offense are increasing dramatically and that we’ll have the cash to do so.

Given the leverage of the firm, as we said in the stated remarks, is 1.9x leverage, we think we’re one of the lowest levered mortgage REITs in the peer group. In terms of opportunities, as I said earlier, the regional bank pullback, I think, is going to be massive. It was very difficult to understand how much they were doing because there were just so many banks in the market literally thousands of them making loans. So where banks I’ve never heard of that we’re doing loans in areas well outside of their region. So we think that those will present big opportunities. In terms of sectors, obviously, given our office exposure today and what’s going on in the office market, we would be hyper selective in office. But in terms of multifamily, hotel, industrial, other property types, we’d be absolutely open to doing that, including doing some construction loans because we think that the regional banks were very heavy in construction lending.

So we think there’ll be good selective opportunities to do construction loans, and that will be a product very well needed. But we think overall for the market to start to move, not only on the supply side with the regional banks pulling back, but we also need to see an increase on the demand side for credit. And we think that’s not going to happen broadly until assets start to trade and until we start to see rates on the short end coming down.

Operator: There are no further questions at this time. I’d now like to turn the floor back over to Michael for any closing comments.

Michael Mazzei: Great. Well, thank you all for joining us today. Please, as always, feel free to reach out and contact us if you’d like to have a one-on-one meeting, and we’ll try to accommodate. Until then, we’ll see you in the third quarter call in November, and have a great rest of summer. Thank you.

Operator: Ladies and gentlemen, that does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.