BrightSpire Capital, Inc. (NYSE:BRSP) Q4 2023 Earnings Call Transcript

BrightSpire Capital, Inc. (NYSE:BRSP) Q4 2023 Earnings Call Transcript February 21, 2024

BrightSpire Capital, Inc. beats earnings expectations. Reported EPS is $0.28, expectations were $0.25.
BRSP isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Conference, BrightSpire Capital’s Fourth Quarter 2023 Earnings Call. At this time, participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. 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 fourth quarter and full year 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 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, February 21, 2024, 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.

Finally, during the call, management may refer to distributable earnings as DE. With that, I would now like to turn the call over to Mike.

Michael Mazzei: Thank you, David. Welcome to our fourth quarter and full year 2023 earnings call, and thank you for joining us this morning. I’ll start by giving a brief update on the fourth quarter and what we anticipate for this year. Then I will turn the call over to Andy for more specifics on the portfolio. Let’s first turn to BrightSpire’s results. For the fourth quarter, we reported GAAP net loss of $16.3 million or $0.13 per share, DE of $25.4 million or $0.20 per share, and adjusted DE of $35.9 million or $0.28 per share. Our dividend coverage for the fourth quarter was 1.4 times. Now let’s briefly discuss the financial markets. While the Fed has been back pedaling on the timing of rate cuts, it is now clear that the hire [ph] for longer policy has come to a close.

This pivot has caused a significant risk on in credit spreads, long duration bonds, and big tech. Even office rates have come off their lows from several months ago. The 10-year treasury yield initially dropped over 100 basis points and is currently about 75 basis points lower versus the October earnings call. In the commercial real estate debt markets, CMBS AAA’s have tightened by roughly 50 basis points, and we saw a very strong investor demand for the first CRE CLO print of 2024, which was also an actively managed structure. The CLO cost of funds has tightened roughly 75 basis points over the past four months. Furthermore, most of our line lenders have expressed interest in increasing their warehouse balance sheets for new loans. And for good reason, as through this cycle, these banks have seen their best credit performance in this segment of their lending portfolio.

For commercial real estate owners, these are clear signals that help us on the way. During the second half of this year, we expect the beginnings of a meaningful reduction in the pricing of interest rate caps. And while lower rates alone will not solve all market issues, it will go a long way in reducing credit stress across all asset classes. Turning back to BrightSpire, 2023 was challenging, but we continue to protect the balance sheet, maintain higher levels of liquidity, and now have one of the lowest leverage ratios in the peer group. Maintaining these liquidity levels, coupled with our smaller average loan size of approximately $34 million, has helped us navigate the last 18 months. As we have stated in the past, it is problematic for liquidity when large loan concentrations constitute multiples of shareholder equity.

On that note, Andy will provide an update on our two largest loans. The ultimate resolutions of which will further reduce our own concentrations. Looking ahead, with rates expected to decrease in the second half of this year, we’re all looking forward to the positive bias this will have on credit quality. Alternatively, our entire sector has experienced earnings increases from the 500 basis points and rate hikes. And now with the coming rate reduction of the Fed funds rate, this positive trend will begin to reverse in the latter portion of 2024. In addition, over the last 18 months, the sector, along with BrightSpire, has recognized write-downs in capital. Further, we experienced capital inefficiencies due to a combination of maintaining higher cash balances, lower leverage from both loan payoffs and warehouse line paydowns, as well as an increase in unencumbered assets.

These factors will be headwinds for earnings later this year. Therefore, the sector’s 2023 dividend coverage levels should not be used as a guide for future earnings. These coverage’s should narrow for most as the year progresses. Now, looking forward, it will be about re-optimizing your existing capital base to offset these factors. Accordingly, in 2024, we will need to reverse the balance sheet trends of the past two years. As I previously stated, overall leverage stands at 1.8 times and our unrestricted cash is approximately $203 million. We also have low or non-earning capital in REO and some other assets. During 2024, we will work to monetize and redeploy this capital more effectively. Importantly, the resolution of watchlist assets and providing more certainty on our loan book should also help close the gap between our market price and book value.

As we execute our plan to further stabilize the balance sheet, we will also begin to assess new lending opportunities. The actual deployment of capital will most likely be a second half of the year objective. Lending opportunities should further open up in 2024. Along with the Fed easing rates, the regional banks will be seeking to reduce their CRE exposures. Keep in mind that regional banks hold about 70% of the commercial mortgages in the bank system. So as loans mature, especially construction loans, these banks will be far less incentivized to refinance these loans on their balance sheets. In addition, more regional banks will be included under the new Basel III rules. These factors will become tailwinds for non-bank lenders. In closing, we are becoming more positive about the opportunity set.

In the not-too-distant future, we will look to play offense for the first time in almost two years. And with that, I will now turn the call over to our President, Andy Witt.

Andy Witt: Thank you, Mike. Good morning, and thank you all for joining. Throughout the fourth quarter, much like the rest of 2023, our focus was on asset and portfolio management. During the fourth quarter, we received $132 million in repayments across four investments, which included a partial repayment of $57 million for the San Jose Hotel loan as a result of sales proceeds from the South Tower. The loan has been paid down to $136 million. The remaining collateral consists of the original 540-room hotel, including all back-of-house infrastructure, amenities, and conference space. The hotel is currently being marketed for sale by the borrower. In addition, during the quarter, we received repayments on two office loans and a multifamily loan.

Subsequent to quarter end, we received an additional $27 million in loan repayments. Looking ahead, we received a repayment notification from the borrower of our largest office loan and expect to be paid off in March. The loan has a current balance of $87 million and a future funding obligation of an additional $13 million. We also anticipate several more loan payoffs or paydowns in the office segment of our portfolio in the coming months, further reducing our exposure to this asset class. Additionally, the sponsor on the South Pasadena, California office loan recently completed upzoning entitlements on land surrounding the existing and fully occupied office building. This upzoning is for residential senior living and far exceeded expectations, substantially increasing the value of our collateral.

While we still maintain this asset in the office segment of our portfolio at year end, we intend to recharacterize the loan next quarter, given the value creation and transformation of the underlying collateral. Lastly, as it relates to office exposure within the portfolio, the Washington, DC office property, which we took ownership of during the fourth quarter, is currently being marketed for sale. We should have more definitive information to share by next conference call. The multifamily portion of our portfolio has largely remained resilient in the face of a difficult macro backdrop. We are seeing a slowdown in top-line growth after years of outsized rental rate increases. We expect top-line growth in the sector to remain relatively flat over the next 12 months to 18 months as new supplies absorb.

Certain policies adopted during COVID have been detrimental to the sector. However, as those policies wind down, operators are making progress on their value-add business plans. We have been working very closely with borrowers on loan extensions and rate cap requirements. Looking ahead, we continue to believe the fundamentals for housing remain strong, and once the product currently under construction is absorbed, there is very little in the pipeline behind it which bodes well for the sector. Turning to our watch list update, the list remains relatively consistent with last quarter. First off, two risk-ranked 5 loans were removed from the list. As previously mentioned, we took ownership of the property underlying the Washington, DC office loan.

Additionally, we also took ownership of the property underlying a previously risk-ranked 5 Phoenix, Arizona, multifamily loan. As we discussed last quarter, the borrower was unable to secure the incremental funds needed to execute the remainder of the business plan. We are in the process of executing a value-enhancing business plan, which we expect will take several quarters to implement, after which time we anticipate taking the property to market. We were able to retain our financing on this Phoenix multifamily property. We had only one watch list loan downgrade during the quarter, a Denver, Colorado, multifamily loan, which was placed on non-accrual and downgraded from a risk ranking of 4 to a 5. The borrower is currently marketing the property for sale.

As of December 31, 2023, excluding cash and net assets on the balance sheet, the portfolio is comprised of 87 investments with an aggregate carrying value of $2.9 billion and a net carrying value of $855 million, or 78% of the total investment portfolio. Our weighted average risk ranking remained flat quarter-over-quarter at 3.2. The average loan size is $34 million, and the loan portfolio has minimal future funding obligations, which stand at $168 million, or 5% of outstanding commitments. First mortgage loans constitute 97% of our loan portfolio, of which 100% are floating rates and all of which have interest rate caps. The multifamily portion of our portfolio remains the largest segment, with 51 loans representing 53% of the loan portfolio, or $1.5 billion of aggregate carrying value.

Office comprises 33% of the loan portfolio, consisting of $960 million of aggregate carrying value across 27 loans, with an average loan balance of $36 million. The remainder of the portfolio is comprised of 7% 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 fourth quarter results. Frank?

Frank Saracino: Thank you, Andy, and good morning, everyone. Before discussing our fourth quarter and full year results, I want to mention that our fourth quarter 2023 Supplemental Financial Report is available on the investor relations section of our website. As Mike mentioned, for the fourth quarter, we generated adjusted DE of $35.9 million, or $0.28 per share, flat to the third quarter. Fourth quarter DE was $25.4 million, or $0.20 per share. DE includes a specific reserve on one multifamily loan of approximately $10 million, where we also took ownership of the underlying property during the quarter. Additionally, we reported total company GAAP net loss of $16.3 million, or $0.13 per share, which reflects a sequential increase in our CECL reserves and a small impairment taken on one REO asset.

For the full year of 2023, we generated adjusted DE of $138.2 million, or $1.06 per share, representing a return on undepreciated shareholders’ average equity of approximately 9.2%. Our dividend for the year of $0.80 was well covered at 1.33 times. Quarter-over-quarter, total company GAAP net book value decreased to $9.83 from $10.11 per share. Undepreciated book value also decreased to $11.35 from $11.55 per share. The change is mainly driven by an increase in our CECL reserves and partially offset by adjusted DE in excess of dividends declared. Looking at reserves, our specific CECL reserve decreased from $35 million to zero. The decrease was driven by the charge-offs related to our taking ownership of the properties underlying the Washington, DC office loan and Phoenix, Arizona multifamily loan.

No specific reserve was required on the Denver, Colorado multifamily loan that was downgraded to a five. Our general CECL provision stands at $76 million or 246 basis points on total loan commitments, an increase of $21 million from the prior quarter. The increase in the general CECL was primarily driven by economic conditions as well as specific inputs on certain hotel and multifamily properties. Looking at watch list loans, our one risk ranked 5 loan represents 1% of the total loan portfolio carrying value. 9 loans equating to 15% of the total loan portfolio carrying value are risk rank 4. While all risk rank 4 loans are current performing loans, we see potential for increased risk and accordingly are monitoring these investments and working with sponsors to ensure the best outcomes.

Moving to our balance sheet, our total at share undepreciated assets stood at approximately $4.4 billion as of December 31st, 2023, a slight decrease in the last quarter. Our debt to assets ratio is 62% and our debt to equity ratio is 1.8 times, a slight decrease quarter-over-quarter. We have no corporate debt or final facility maturities due until the second quarter of 2026. In addition, our liquidity as of today stands at approximately $368 million. This comprises the $203 million of current cash that Mike referenced earlier, as well as $165 million under our credit facility. This concludes our prepared remarks and with that, let’s open it up for questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] First question comes from Sarah Barcomb with BTIG. Please go ahead.

Sarah Barcomb: Hey, everyone. Thanks for taking the question. I just wanted to dig into the multifamily portfolio here. Those additional downgrades related to sponsors not willing or unable to buy new interest rate caps for the most part, and can you provide any commentary on your overall exposure to syndicated sponsors that might have bought these properties during that low interest rate period?

Michael Mazzei: Hey, Sarah, it’s Mazzei. I’ll start off with that. I think Andy can add some color there as well. Yes, so the downgrades were, there are some syndicators in that. Yes, I think that syndicator exists across many portfolios. There are issues with execution on those specific properties. Some of them are related, as Andy said in his stated remarks, there were COVID-related policies that inhibited owners from moving tenants out of the assets. And so there were value add issues in terms of, the business plans in terms of executing on value add. So we had some of those issues with regard to the property that went REO. As Andy said, it could take us a couple of quarters, several quarters to move out of that. So yes, we had some issues with the syndicator.

We are closely monitoring that. Our exposure is limited. It’s been a handful of assets that we’ve had. One of the assets on the watch list is being supported by the preferred equity behind the asset, but we continue to have it on the watch list as well. In terms of interest rate caps across the portfolio, multifamily borrowers are buying caps. They are seeing visibility in terms of ultimately getting across the bridge, as Andy said, through the supply and getting on with their programs. So borrowers generally in multifamily have been sticking with the assets and buying caps. Andy, anything you’d like to add to that?

Andy Witt: No, I think, Mike, you covered it. The one asset that went from a risk-ranked 5 to REO is currently in the process of going through renovations and lease-up, and that’s a process that we expect to transpire over the next couple, three quarters, after which time we expect to take that asset to market on a more stabilized basis.

Sarah Barcomb: Okay, great. Yes we’ve seen some of these multifamily noise across the space this quarter, and that’s to be expected just given where SOFR is these days. But just shifting over to office, it seems like there’s some positive telegraphs here for the office portfolio, expecting some repays in the future here. There was one downgrade, but it wasn’t watch-listed. Basically, my question is, at this stage, do you feel that the office credit is pretty well ring-fenced at this point?

Michael Mazzei: I wouldn’t go as far as to say that. Honestly, I don’t think anybody can, given the work-from-home issues that are out there. The issue with office is going to be getting taken out of those assets with refinancing. And so I think right now that has proven to be very difficult, and you’re seeing that being reflected in some of the severities on loans that have been taken back. So generally on office, I’d say, as Andy said, we are in the process of selling the Washington, D.C. asset. I think we have some encouragement there on the number of bids we got, and we’re working through reviewing those bids now, and we’ll have something more to say on that. Generally in the office portfolio, the Q4, it was Sarah stable.

We didn’t see anything that was slipping materially. We have had some successes. As Andy said, the largest asset that we have has indicated that they’re paying off the loan. The South Pasadena asset with the upsizing and zoning was so substantial that we actually may recharacterize the loan. The Baltimore asset, which we’ve talked about in previous quarters, is now 90% leased with what will be, when the tenant takes occupancy, a very high debt yield. In San Francisco, we have two assets that are smaller. Both are fully occupied with new leases. We did a spec deal in LA for a single tenant that is now going to be fully occupied. And as Andy also mentioned, there are assets on the horizon that we think are going to pay off, most notably an asset, an office asset in Florida.

So we’ve seen some good positive movement there. But for the rest of the portfolio, it’s about visibility for the borrowers. And unlike what I just said about multifamily, where borrowers see housing shortage and over the horizon, they say, these are assets that we know will ultimately perform. So they’re sticking with them generally. And we’re seeing a lot of liquidity in that market. The REO asset that we are working with the borrower, he’s marketing the asset for sale on that. And I think they’re seeing a lot of interest in that asset. There’s not much more I can say, but there’s a lot of interest and a lot of liquidity on the multifamily side. The office assets, those are the assets we’ll be watching more closely in terms of confidence around deploying capital.

So while we’ve had some market improvement this quarter in terms of what will be a reduction in the portfolio, I still think going forward, that’s the area that we’ll be watching more closely because those borrowers have the least liquidity in terms of refinancing. But otherwise, the quarter was, for the balance of the portfolio, the quarter was absolutely stable, yes.

Sarah Barcomb: Great. Thank you for all that detail. Appreciate it.

Operator: Thank you. [Operator Instructions] Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws: Hi, good morning. Mike, I guess to start, it seems like you’re incrementally positive as you look out later into this year. What prevents you from going on offense sooner given the very low leverage and liquidity position? Do you want to see the expected repays on office get across the finish line? Is it something else that you want to see macro, maybe rates start to roll over and get better visibly? Given the kind of seems like improving tone, why do you feel the need to wait another four to six months to kind of go back on offense?