Franklin BSP Realty Trust, Inc. (NYSE:FBRT) Q2 2023 Earnings Call Transcript

Franklin BSP Realty Trust, Inc. (NYSE:FBRT) Q2 2023 Earnings Call Transcript August 1, 2023

Operator: Good day, and welcome to the Franklin BSP Realty Trust Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe, Director of Investor Relations. Please go ahead.

Lindsey Crabbe: Thank you so much. Good morning. Welcome to the Franklin BSP Realty Trust Second Quarter Earnings Conference Call. As the operator already mentioned, I’m Lindsey Crabbe. With me on the call today are Richard Byrne, Chairman and CEO of FBRT, Jerome Baglien, Chief Financial Officer and Chief Operating Officer of FBRT and Michael Comparato, President of FBRT. Before we begin, I want to mention that some of today’s comments are forward-looking statements and are based on certain assumptions. Those comments and assumptions are subject to inherent risks and uncertainties as described in our most recently filed SEC periodic report and actual future results may differ materially. The information contained on this call is current only as of the date of this call, August 1, 2023.

The company assumes no obligation to update any statements made during this call, including any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Additionally, we will refer to certain non-GAAP financial measures, which are reconciled to GAAP figures in our earnings release and supplementary slide deck, each of which are available on our website. We will refer to the supplementary slide deck on today’s call. With that, I’ll turn the call over to Rich Byrne.

Richard Byrne: Great. Thanks, Lindsey, and good morning, everyone. Thank you all for joining us today. As Lindsey said, I’m Rich Byrne. I’m the Chairman and CEO of FBRT. Also, as Lindsey mentioned, our earnings release and supplemental deck were just published to our website yesterday, so you can look at them there. We’re going to begin today’s call by reviewing our second quarter results. And then, of course, as always, we’ll open the call up for your questions. I’m going to start on Slide 4. FBRT delivered very strong earnings in the second quarter. In particular, our distributable earnings per share increased 50% this quarter, with the company generating $0.66 per fully converted share compared to $0.44 in the prior quarter.

Our quarterly dividend of $0.355 remains well covered by our distributable earnings that also is well covered by our GAAP earnings. This dividend level represents a yield of approximately 9% on our June 30 book value of $15.85 per fully converted share. The large increase in distributable earnings this quarter was largely attributable to the gain from our resolution of Williamsburg — our Williamsburg hotel loan. In April, the hotels sold for $96 million. We recovered 100% of the principal on the loan and approximately $20 million of additional proceeds. Jerry, when I turn it over to him, we’ll provide more explanation about the sale and the accounting treatment of the gain later in this call. Excluding the impact of the Williamsburg loan, our portfolio performed as expected this quarter, with earnings modestly improving due to the benefit of higher base rates on our floating rate portfolio.

Our book value increased by $0.07 in the quarter to $15.85. The retention of excess earnings over our dividend more than offset the increase in our general CECL provisions and our one asset-specific CECL provision. And speaking of reserves, we took a proactive approach to risk management as evidenced by the increases this quarter and every quarter that we’ve taken on our portfolio. Notably, four assets were moved on to watch list in the second quarter with a risk rating of 4. And of those two were office loans and two were multifamily loans. And one loan on our Portland office complex, that was previously on watch list was moved to a 5 and is now on nonaccrual status. We also took an asset-specific reserve on that loan. In its entirety, our watch list consists of five loans, which are four 4-rated loans and one 5-rated loan.

And that aggregates to approximately $145 million in value, which represents 2.9% of our $5.1 billion portfolio. We believe these watch list ads and the reserves attached to them are appropriate for our portfolio. Mike will go into greater detail about our watch list loans and our approach to our credit quality assessments, hence, our ratings later in the call. Turning to our REO properties. We have a few updates on those as well. Our total REO loan positions decreased this quarter with the sale of our multifamily asset in New Rochelle, which closed in the second quarter. The assets sold for our marked value on the position, so no additional write-down was required. Regarding our Walgreens portfolio, as of quarter end, we now own all 24 Walgreens properties underlying this loan.

The leases on all 24 stores currently have 15-year lease terms. We intend to focus on liquidating the portfolio beginning in the third quarter. The 24 stores make up an asset value of approximately $100 million, which is the vast majority of our foreclosure REO balance at quarter end. I would now like to cover a few more points before I turn things over to Jerry. One, despite the subdued transaction environment during the quarter, we originated $230 million in new loan commitments, maintaining our portfolio size of $5.1 billion. Our portfolio is well diversified across 156 loans with an average loan size of $33 million. Multifamily represents 77% of our portfolio. And as we have said before, multifamily lending will remain our focus. Mike will provide more detail on our recent investments and our pipeline in his commentary.

We had $1.2 billion in total liquidity as of June 30. Of that, $225 million was our cash balances. This gives us maximum flexibility to take advantage of opportunities while also maintaining a strong liquidity cushion to protect our portfolio from any unforeseen credit events. We repurchased $5.5 million of common stock during the quarter. In aggregate, over the past 2 years, we purchased more than $60 million of our stock. We still have $39 million remaining on the company’s buyback authorization, and we will not hesitate to repurchase our shares when we determine it to be the best use of our capital. To conclude, while we continue to see a challenging environment for commercial real estate and the market overall, we believe our portfolio is well positioned.

We are focused on maintaining a strong capital position, which will allow us to continue to invest in our portfolio but also play offense when we see good opportunities to originate. We are confident we can navigate through the challenging market conditions while delivering long-term value to our shareholders. With that, I’ll let Jerry discuss our financial performance. Over to you, Jerry.

Jerome Baglien: Great. Thanks, Rich. I’m Jerry Baglien, the Chief Financial Officer and Chief Operating Officer of FBRT. It’s great to have everyone on the call today. Moving on to our results. Let’s start on Slide 5. FBRT generated GAAP earnings of $39.6 million or $0.39 per diluted common share, representing a 9.8% return on common equity. GAAP net income was down quarter-over-quarter as the first quarter had onetime contributions from security sales and gain on debt extinguishment. And in the second quarter, the large gain on the Williamsburg resolution was mostly offset by CECL reserves. Our distributable earnings in the second quarter were $63.5 million or $0.66 per fully converted share, representing a 16.5% ROE. Our walk through of our distributable earnings to GAAP net income can be found in the earnings release.

As Rich discussed, the sale of the Williamsburg Hotel was the biggest driver of our distributable earnings beat. The $20 million in additional proceeds consisted of accrued interest that we received on the loan. We originated $230 million in new loans during the quarter while also receiving paydowns to $232 million which kept our portfolio flat to first quarter at $5.1 billion. Our portfolio size was flat in the quarter, and we maintained a large liquidity position. The cash flow on our portfolio currently generates comfortably enough to cover our dividend. As a result of this, we can continue to be deliberate in our originations and wait for the right opportunities. Our net leverage position remained modest at roughly 2.4x this quarter. We are deliberate in our use of leverage and view it as a structural highlight.

Moving to Slide 6. You can see the layout of our distributable earnings growth. The portfolio performed well, and distributable earnings would have been similar to the first quarter without the onetime benefit from the sale of Williamsburg. As I mentioned, our GAAP net income reflects the increase we took as part of our CECL provision. We endeavor to use conservative CECL assumptions for both, general and specific reserves. Our total reserve increased by $21.6 million this quarter to $52.1 million, with 59% of the total reserves on multifamily. Office assets accounted for 25% of the reserve despite representing only 6% of our portfolio. Our specific reserve this quarter was attributable to our Portland office property. It was downgraded to a risk rating of 5.

We engaged a third-party valuation firm to determine the market value of the property. And after reviewing and agreeing with their change in value, we took an asset-specific reserve of $11.9 million, which is included in the total reserve amount discussed previously. Our carrying value of the asset was approximately $33 million and is now $20.4 million post the adjustment. Mike will share more details on the watch list in his comments. Moving to Slide 7, you can see a walk of our portfolio. I’ve discussed new originations, but I also want to provide similar details to last quarter on our repayments. The majority of repayments were from hospitality and multifamily loans, contributing 50% and 37% of the balance, respectively. The other item to note is the $38 million decrease in our core loan portfolio, which was moved into REO.

This was due to us taking the title to the remainder of the Walgreens portfolio. The Walgreens position comprises the majority of the balance in foreclosure REO with the other property being an office building that we foreclosed in St. Louis. As we have discussed, while never our outcome of choice, we are comfortable holding positions in REO. Our team has expertise in owning and operating assets. This comfort affords this time to execute sales at the best levels. I will also note our entire foreclosure REO position represents approximately 1.8% of our total assets. We can move on to Slide 8 and discuss our capitalization. Our average cost of debt during the quarter was 7.3%. The increase in our cost of debt has trended up with the increases in SOFR and LIBOR as our debt primarily floats.

7% of our financing sources on our core portfolio are nonrecourse, non-mark-to-market. As of quarter end, we have reinvested available to us on four of our CLOs. We will continue to actively manage our CLO book. We did observe some CLO issuance activity during the quarter from other issuers. We participated as an active buyer of these bonds, and we find them to be attractive additions to our portfolio on a levered yield basis. While CLOs remain our preferred financing mechanism over the long term, we have seen attractive rates on our warehouse lines. We are constantly watching CLO markets and will engage in new issuance should the opportunity present itself at levels we believe to be attractive. Subsequent to quarter end, our FL 5 CLO was redeemed.

This was relevered at an advance rate of 67% and freed up approximately $52 million of cash. On Slide 10, and Rich touched on this, the importance of our liquidity position going into the second half of the year, we have $1.2 billion in available liquidity. Our CLO reinvest balance tends to be relatively low because of how closely we manage to reinvest on our deals. When a loan repays in a CLO, we look to fill it quickly, which keeps this cash balance at 0 or close to it. Our goal is to minimize any cash drag that may occur from the repayment on our loans in the CLOs and backfill with loans we have financed on our warehouse lines. This, paired with our cash position and available capacity on our warehouse lines and revolver, stabilizes our balance sheet and positions us to transact in the coming quarters.

With that, I’ll turn it over to Mike to give you an update on our portfolio.

Michael Comparato: Thanks, Jerry. Good morning, everyone, and thank you for joining us. I’m Mike Comparato, President of FBRT. I’m going to start on Slide 12. I’ll focus today on key attributes of our commercial loan portfolio, current market opportunities and will provide an update on our watch list assets. Similar to prior quarters, our collateral remains focused on multifamily, with 77% of our exposure in this sector. It was also our largest addition this quarter. We continue to barbell the portfolio with multifamily being our mainstay asset class and sprinkle in some hospitality, industrial and retail. Hospitality was our second largest ad in the second quarter. We have not seen improvement in the Office sector. We have discussed for several quarters that Office has an identity crisis, and that crisis only appears to be worsening.

We anticipate tens of billions of dollars of Office loan defaults in the coming years as we are already witnessing countless owners merely walking away from assets at loan maturity. During the quarter, we downgraded two of our Office loans to a 4 risk rating, and our reserves were appropriately increased to reflect further weakness. Thankfully, our Office exposure is only 6% of our total portfolio and overall, is performing very well at the asset level. Geographically, our focus continues to be across the Southeast and Southwest. You’ll note we added a breakout by state this quarter in our presentation to provide more transparency into the portfolio, and we’ll continue to provide more clarity in future quarters. We have no intention of adding international exposure to our portfolio in the near future.

We can move to Slide 13 for specifics on our quarterly originations and current market quality. 7 loans were originated this quarter at a weighted average spread of 432 basis points. The credits we are writing today are some of the highest credit qualities we have seen in years. Market conditions are creating opportunities and deals are becoming more attractive. Banks are clearly on the sidelines for new direct origination. And a meaningful subset of our competitors in the mortgage REIT and debt fund space are focused on legacy portfolio concerns versus adding new additional risk. With approximately $1.5 trillion of commercial mortgage real estate loans maturing in the next 3 years, we believe the environment to be right for well-capitalized alternative lenders with dry powder.

FBRT clearly being one of them. Acquisitions overall are quite slow, although improving as the bid-ask spread between buyers and sellers and [indiscernible]. Multifamily transactional volume for the first half of 2023 was the lowest since 2011. That said, we are starting to see more acquisitions and getting some price discovery within the stabilized multifamily market. For several quarters, we have discussed negative leverage [indiscernible] to leave the system prior to transactional volume returning to historical norms. In the stabilized multifamily sector, we are seeing buyers accept 1 to 2 years of negative leverage via 10-year low leverage interest-only fixed-rate agency debt with the expectation that they can grow NOI to positive leverage in year 3 and beyond.

However, transitional multifamily transactions continue to have meaningful negative leverage. And the deals we are seeing in the space appear to be more force sellers versus willing sellers. Office remains the clear industry Debt is more difficult to obtain than any time in history, perhaps other than 2009. Passive tenant retention is hitting all-time highs in many cases, noneconomically logical levels, uncertainty abounds. Will Office become an opportunity in the future? Absolutely, but we will be very selective. It is uninteresting at the pricing levels of the past few years. But when it is priced appropriate to other risks in the market, we may be interested. As Jerry mentioned, we have been an active buyer of CRE CLO bonds, buying AAA-rated bonds with 7 to 8 handle coupons that produce leverage returns in excess of 20%.

It’s hard to consider writing a loan on an office building when a AAA bond can make you equity-like returns. The last thing I’ll review today is our watch list loans. Let’s look at Slide 14. As Rich mentioned, we have 5 loans on watch list as of June 30. Two loans were removed from our watch list in the second quarter. The Walgreens loan was moved entirely to REO, and the Williamsburg Hotel came to a positive resolution in April. One loan that was moved on our watch list — one loan that was moved on to our watch list in the first quarter and office complex in Portland was downgraded to a 5. Jerry provided information on our mark and the asset-specific reserve in place on this loan. We are in active dialogue with the borrower and would expect to take the property as REO in the third quarter via [indiscernible] foreclosure.

The new loans added to watch list this quarter include a CBD high-rise office building in Denver, Colorado, a suburban Class A office building in Alpharetta, Georgia, a garden-style apartment community in Arlington, Texas, and a garden-style apartment complex in Lubbock, Texas. In aggregate, the 4 new watch list names totaled $113 million in principal balance. Our reserves have been increased this quarter to reflect the change in credit quality. We are in close communication with the borrowers on each loan and will determine the appropriate path forward to each resolution. The team has a history of cleaning up watch list loans quickly, and our asset management group is actively engaged across the board. I want to take a moment on the methodology of our risk ratings.

A loan that is risk rated for is the loan we identify as not meeting its business plan at initial origination. It is not necessarily a reflection of the loan we expect to take a future loss. Those loans, we risk rate 5. Take, for example, the loan I mentioned in Arlington, Texas, that we added this quarter to our watch list as a 4. This property is underperforming on its original business plan. However, the loan will receive a pay down this week and is currently under nonrefundable contract to be sold, resulting in a full repayment of our loans, assuming the sale closes. We perform a thorough review each quarter of all assets and have a disciplined approach to increasing our general and asset-specific reserves as we deem appropriate. We are proactive in managing any potential risk in our portfolio and have made incremental improvements to our credit positions with loan modifications made during this quarter.

Our goal is to identify issues and resolve them quickly, allowing asset management and senior management to have as few balls in the air at the same time as possible. We believe the company’s existing portfolio composition will continue to position us as an industry leader and give us the opportunity to play offense while a substantial portion of our competitive set cannot. With that, I would like to turn it back to the operator to begin the Q&A session.

Q&A Session

Operator: [Operator Instructions]. Our first question comes from Sarah Barcomb with BTIG.

Sarah Barcomb: So we saw some multifamily assets go on watch list. One of them will see a near-term repayment for us. So that’s good to hear. But could you talk about the potential for future watch list migration as additional multifamily loans that were originated during that low rate 2021 period reached their initial maturities next year? How should we think about the debt yield on those assets, particularly maybe those in Florida where we keep hearing about higher expenses and rent growth softening, themes that we’ve talked about before? If you could speak to that, that would be great.

Michael Comparato: Sarah, it’s Mike. I’ll take that. So I’m going to start with the back half of your question first. I think the expense growth that we’re seeing is not necessarily specific to Florida, but we’re kind of seeing it across the portfolio. I think the expense side of the income statement is catching up with the rent growth that we saw in 2021. And most notably, Texas and real estate taxes, most notably in any kind of coastal markets in property insurance, where we’re seeing insurance double, in some cases, triple. As we’ve mentioned previously, I think for the several next quarters, we’re going to continue to see new additions to watch list loans, resolution to watch list loans and then dealing with a new subset of watch list loans.

So I think it’s just the reality of the environment that we’re in. When rates go from sub-3% coupons to 8% or 9% coupons, there’s just going to be a fairly consistent stream of loans that we’re going to be working through over the coming quarters. I think we’re overall pretty positive about our position within the multifamily sector, certainly with 77% of the portfolio exposed there. We think overall, the multifamily market has probably witnessed a 20% to 30% correction in valuations. 20% likely more for newer vintage assets in larger markets, probably closer to 30% for some older vintage assets in secondary and tertiary markets. But we think that we’re positioned very well based on our basis. We’ve seen hundreds of millions of loans pay off.

We’re seeing some assets trade, Arlington being an example, above our debt basis. And so overall, I think we are generally positive on our portfolio. It doesn’t mean we don’t have a lot of work to do every quarter in working through these positions. But as it stands today, we are not concerned that losses within the multifamily sector on a macro basis have carried over into the debt portion of the capital stack for FBRT.

Sarah Barcomb: Okay. And maybe just switching over to the debt side. You touched on CLO capacity as well as seeing some more attractive rates on the warehouse lines. Could you also just talk about your levers for more defensive liquidity, just given the potential for taking the keys back on some of these assets? And in that context, how do you think about how we should measure the amount of real estate owned that can come on to the balance sheet at once? Maybe with some further commentary on the broader Benefit Street platform and the capabilities there. Curious for your thoughts there.

Michael Comparato: So I’m going to let Jerry handle the first part of that question with levers and liquidity and leverage. But let me just address quickly the second half of the question with respect to REO. Watch list assets and REO, we have the same view, fix them fast and move them fast. And unless we see some sort of meaningful upside in holding an REO asset, as Jerry mentioned. We have an equity practice within the real estate group at Benefit Street. We’re very comfortable owning commercial real estate assets, and we believe we can add value on commercial real estate assets. So if we take something REO, it’s either a quick liquidation at a price that we think is acceptable to us. But if we believe that we can get better execution in the future, whether that’s from market improvement or improvement that we can make at the asset level, we will certainly explore that. But we have very, very little interest in owning REO long term within the vehicle.

Jerome Baglien: Yes. And then just in terms of our ability to finance things. I think we’ve spoken tons about our ability to reinvest into our CLOs. And we’re going to have that capacity for some time to come across the 4 that still have reinvest. The next one burns off in mid-September, but then you’ve got December, February into July of next year. So there’s a decent amount of relatively short-term capacity that we can take things off warehouse lines and free up space there. And we can use those warehouse lines to, in some cases, take back assets if we need to. We can hold a decent amount on levered too. I mean if you look at our leverage point relative to a lot of the peer set, I think we run at a pretty low leverage, which gives us a little more flexibility too, if we want add debt in other ways.

There’s other debt options that we haven’t tapped in terms of unsecured or other similar options. We haven’t chosen to go down that path, because we don’t need it, and we’d rather run with less leverage right now. But we certainly have that ability to flex it if we ever really want to in the future. But right now, I think we’re pretty comfortable with our position. We have tons of capacity across our different options, and we’ll flex those as needed as we need to work through things. But I think Mike kind of hit the most important part which is really trying to cycle through whatever may come up. I think we’re very proactive on monitoring our portfolio and trying to work through things in advance of them becoming issues that end up on the balance sheet directly as REO or unlevered loan positions.

And so I think that’s probably the most productive way to sort of stem off the secondary part of your question, which is how would you deal with the liability side. So I think proactive asset management involvement is probably the key part of that.

Operator: The next question comes from Matthew Erdner with JonesTrading.

Matthew Erdner: Mike, you mentioned in the earnings release about AI. How much are you looking to invest here both dollars and attention? And I guess what kind of business lines are you going to use, whether it be underwriting portfolio monitoring. Could you just expand on that a little bit, please?

Michael Comparato: Sure. I don’t think we have a dollar amount circled at this point. Our co-CEO, David Manlowe of overall BSP has made it a very front burner big-picture initiative for the firm. So it’s across the entire platform where we’re turning attention to AI, how it can add alpha to every aspect of our business. We are already utilizing it in some capacity within our origination platform. And we’re looking to see how it can add value, whether it’s a second or third set of eyes. We’re not sure exactly what role it plays, but how does it — how can it help us through our legal processing. How can it help us through our underwriting process? How can it help us through asset management? I think we’re clearly in the very, very early days of AI, but we want to be on the forefront of technology and using it for the best of our ability to just be a leader in the space.

So any way we can find an advantage, we want to do that, and we’re exploring it kind of across the board.

Matthew Erdner: Awesome. That’s helpful. And then going to REO and other expenses, would that be where the REO expenses were for the quarter?

Jerome Baglien: Yes. That’s generally where they’re going to flow through.

Matthew Erdner: Okay. And then you know the percentage of what that was for the quarter for REO?

Jerome Baglien: I don’t have that number in front of me right now. It’s relatively small if you think about what we hold. The Walgreens assets are triple net. So there’s very limited expense in terms of what’s occurring there. What you’re going to pick up is some residual from the New Rochelle asset, which moved off in the second quarter. And then the balance is going to be from the St. Louis office, which is a pretty small position. So once the multi assets gone, it’s going to be a very small contribution to expense in terms of what REO is generating on the balance sheet, because the $100 million of that number is triple net. So it has virtually no bearing on expense.

Operator: The next question comes from Steve Delaney with JMP Securities.

Steven Delaney: Congratulations on resolving Williamsburg and the net lease portfolio. Just to be clear, in case we get this question, with respect to the Williamsburg resolution, did you have to provide any financing to the new owner of the property or was that all — they got their own financing?

Michael Comparato: Thanks, Steve. It’s Mike. We had a lender in the original — a subordinate lender in the original loan that we had mentioned to the borrowers. That lender provided an acquisition loan for the new buyer. And then we provided note-on-note financing to that lender. So we have an incredibly low leverage exposure to the hotel through kind of a leveraging of the mortgage asset.

Steven Delaney: It sounds like good teamwork with your original mezz lender just to get the first eat off your books. So good work out there, no questions. And as you reported, you had a nice gain and you — it sounds like you received all your accrued interest and fees as well. So good work out on that. Mike, I’m still sticking with you. Talk a little bit about the conduit outlook in the second half of this year, just sort of the overall market. How do you see liquidity and new issuance? And you guys have just kind of quietly been putting up a couple of million dollars here and there in fees. So what’s your expectation over the next few quarters for FBRT’s activity level? And for modeling purpose as analysts, should we expect some fee income gains continuing to come in the near term?

Michael Comparato: Yes. It’s been a really difficult business line to model on a go-forward basis. It’s really been schizophrenic. As I’ve been describing to a lot of people, I feel like this rate increases, we’re finally kind of through the 5 stages of death, and we’re finally at acceptance. Borrowers are accepting the fact that they just can’t borrow at 3% and 4% anymore. And rates are where they are. So I can’t directly answer the question in what do I expect for the second half? I will say we find it to be an incredibly important part of our business. When it’s working well, it’s a very high ROE business. I will say we are investing in the space. We’re actually actively hiring new origination within our conduit group. So we’re really hoping that volume picks up.

It’d be hard for it to get much worse than it’s been. So we’re hoping that it’s moving in the right direction, but we’re really investing around the product going forward in hopes that we do see more volume going forward.

Steven Delaney: Yes. I think that’s helpful. And I think what I would do in a situation like that is probably plug in something over the next year but not put too much on the table for the next quarter, because you never know whether the next quarter is going to come up with anything. But that’s helpful, and I appreciate the comments this morning.

Operator: The next question comes from Stephen Laws with Raymond James.

Stephen Laws: I want to start — solid quarters, so congrats on that. But I want to start with the originations. You guys are one of the few companies doing new originations. Can you talk about what the current lending market looks like? Who are your main competitors since a lot of other commercial mortgage REITs are not active on the new origination side? And kind of what’s the difference in spread you’re seeing across various property types as you do the due diligence on deals in the pipeline?

Michael Comparato: Steve, it’s Mike. Thanks for the question. As I mentioned in the prepared remarks, I mean, I think banks have largely exited the direct origination business. I also think a lot of the mortgage REIT and debt fund space is concerned with legacy issues and really aren’t looking to add new risk at the time. Keep in mind, we probably originate as wide a swath of loans as anyone out there from every single asset class, but we’re also doing bridge financing, construction financing and permanent financing. So the competitive set is different in virtually everything we do, right? So in the construction loan space, we’re seeing more debt funds play there in the bridge lending space. We are seeing, you have new vintage debt funds, maybe XYZ company Fund 2, 3 and 4 and do anything, but they’ve got Fund 5, and they’re trying to actively lend out of Fund 5.

So it’s really case by case. What I can say fairly definitively is over the past few months, spreads have continued to tighten. And as I mentioned last quarter, I don’t necessarily think that’s a reflection of credit quality as much as it is a scarcity of product. We all know what a good credit looks like. And when the guys with dry powder see it, we’re seemingly all competing for that strong credit quality loans. So I would say today, multifamily generically is probably $325 million to $350 million over as transactions get over $20 million, probably gravitating closer to that $325 million mark. Hospitality — and I would say industrial is largely on top of the spreads. Hospitality, I would say, is probably $450 million to $500 million for kind of the highest leverage hospitality loan that we’ll consider today.

retail, probably the same spot. We’re not seeing much on the retail side today, to be honest. And then Office, I mean that’s just as opaque as it’s ever been. I don’t think anyone could tell you what the straight face would it cost to borrow money today on an Office portfolio or an office loan.

Stephen Laws: I appreciate the color on that and certainly understand the last point. And as a follow-up, I’d love to shift over to the security side. You guys added some in 2Q. I think that was often a new issue CLO. Can you talk about your appetite for more securities? Will those be kind of new issue CLOs or secondary market purchases? What type of deals or collateral are you looking for? And as you think about bigger picture in the CLO markets, Mike, I think everything has been static deals so far, as a AAA buyer would you be receptive to deals with reinvestment period starting to reemerge? Or how do you think about the reopening and improving liquidity on the CLO market?

Michael Comparato: I mean the rally that we’ve seen, I think, throughout the stack has been pretty impressive in just a matter of weeks. Tightening within the AAA is probably 50 basis points at this point. Look, I think the market, unlike 2021 is finally getting to a point where it’s tiering issuers. And I think we would be open to reinvest with issuers that we think highly of. On the flip side, we hope the market thinks highly of us. And if we issue, they’ll be buying our bonds on a reinvest basis as well. We, as a firm, don’t really believe static CRE CLOs are the greatest structure for us as an issuer. We love buying the bonds, but we just don’t like issuing that. We really like the flexibility and the duration of managed deals.

In terms of overall exposure, I would say we’re probably getting closer. We like the relative value. We like the returns we’re generating today. Obviously, the flip side of that is these are mark-to-market assets. And if you’re using leverage, that leverage can go away relatively quickly. So I don’t see us getting significantly larger on our bond book today. If anything, we might sell into this strength a little bit. When all said and done, I would love to just have a portfolio of great mortgage loan credits. And we’ll probably, again, look to sell into the strength if we think we can originate loans to offset kind of that NIM that would be coming off through bond sales.

Richard Byrne: Steven, it’s Rich. Just to tag on there. I assume underlying your question is the same head scratch we’ve been doing is that most of our commercial mortgage REIT public comps, at least really aren’t doing any — much of any origination at all. And the head scratching is because, as Mike said, I mean, the vintage of deals that we’re seeing now, I mean, they’re just really high quality, and it’s also great to have you pick up the litter as well without a lot of competition. Why is that? I don’t know. I mean from our perspective, we have a lot of cash, well in excess of anything we think we need to keep around to fix any unforeseen credit problems. And in our case, we have — you heard us talk about Walgreens. Those are pretty attractive investment-grade, triple-net assets appealing world, et cetera.

That’s the $100 million more potentially of liquidity that may come our way sometime soon. As our multi portfolio continues to pay down, so I mean, if you don’t spend money, what’s the alternative? And does it get cheaper later? Maybe, I don’t know. But certainly, it’s hard to see sort of not being a relatively active participant in the market today. And as Mike described, they’re just the conventional competition banks included, just aren’t out there. I assume that’s going to change. And I assume other people are maybe pulling in their wings, their horns, whatever the expression is because maybe they’re just concerned about future credit problems. The truth of our world is everybody — we provided this quarter a debt maturity schedule in the appendix of our earnings supplement.

But the reality is for us and every other commercial mortgage REIT, we generally make 3-year loans, rates started going up last year. So guess what? In this year, next year and the following year, you’re going to see, hopefully, the entire books mature, which means whether it’s — if you have a high degree of Office exposure or whatnot, it’s just something you’re going to have to deal with. So we assume that most commercial mortgage REITs are really primarily focused on that and secondarily focused on everything else. Our — just the way we look at the world, we have a lot of liquidity. The market feels pretty cheap. Sure we can buy securities, but we can do our core business of making loans, that feels like a pretty good bet right now, especially since companies like ours are benefiting from a tailwind of higher rates, and we’re already covering our dividend.

So what you’re investing is indeed truly opportunistic.

Operator: [Operator Instructions]. The next question comes from Matthew Howlett with B. Riley.

Matthew Howlett: Rich, just to follow on, I mean, in the past, you’ve sort of given out a target loan portfolio, and I think you sort of said in your prepared remarks that you’re going to be opportunistic. I mean is there a target, can you give us that by the end of the year? Or is it just sort of too early to tell? And you have these — all these options. You can buy back stock, you can buy securities, you can do other things with your excess capital. Just — is there a target on the core loan portfolio by the end of the year or next year?

Richard Byrne: Let me start — let me give you an initial answer and then maybe Jerry or Mike might want to elaborate. First of all, I think all of the above always applies to us. We’re going to use our capital to where we think we can create the most shareholder value. For a while, that was buying back our stock. We were extremely active in the market buying our shares when it was really cheap. We even bought back some of our bonds. We bought those at a nice discount. So all accretive, and I think great returns. We’ve also been using our cash to make loans. And as I said, as Mike has talked about, the vintage of loans that we’ve seen more recently has been some of the best we’ve seen maybe in forever. So we’re going to be actively deploying our cash.

Jerry can speak maybe more specifically how we’re thinking about leverage and whatnot, but we have $225 million of cash. We have well over $1 billion of liquidity. And as I mentioned, we have some cash sources heading our way. And we have loans repaying if everything goes the way it’s supposed to. It’s a bit of a hamster wheel. We’re just on a treadmill. So I think there’s some minimum amount just to maintain the portfolio size. And if we can grow it we’re just going to do it opportunistically. As I said, we’re covering the dividend already. But Jerry or Mike, if there’s any specific guidance you want to share, please do.

Jerome Baglien: Yes. Maybe I’ll start, Mike, and let you chime in. But I think the target portfolio size concept for me is more of a target ROE concept overall, not necessarily a given number on AUM of loans outstanding, because the yield that we’re generating today is so much higher because of base rates having moved up so substantially. So we sit here today with a $5 billion loan portfolio that’s covering our dividend fairly comfortably. Right now, it just gives us flexibility. And that flexibility can go — like Mike said, can go into securities in the short term, it can go into loans. I think we even have a little room to let it go down slightly if we want and still cover the dividend. So for us, it’s really just a great opportunity to be opportunistic, I think, with how we originate and really take credits that we like.

And if we see really good opportunities, it’s a chance for us to grow that ROE overall. So I think the downside is making sure we maintain the yields that we set for investors in the form of our dividend. And then beyond that, when we do see those things in bonds or loans, we add them on, and hopefully, we can grow our earnings overall as we go forward. So that’s kind of high level how I think about it.

Michael Comparato: Yes. And I don’t want to add too much. I think those guys answered it all appropriately. I will say, I think the company is phenomenally positioned right now. Our asset allocation, I think, is the darling of the sector. We have ample cash. Everybody in the market knows that we are active. We’re getting looks that are outstanding. And I think there’s a lot of dislocation that’s coming over the course of the next 12 to 18 months. Sarah alluded to it in her question, but all of these loans are maturing in the next 18 months. And I think we’re going to be one of the groups with a lot of dry powder to pick up the pieces, at what I will say are probably the highest coupons we’ve seen in 3 decades. So to have that backdrop with our balance sheet and the condition it’s in, the cash position and the condition it’s in, this is a very, very exciting time, I think, for the group at FBR.

Matthew Howlett: Yes, I’ll certainly commend you on buying back stock too, the few REITs doing it here now in this environment. I appreciate those comments. And just — I know you said on the multifamily is going to be the predominant asset class. You did a hotel loan. I’d love to hear what your philosophy is on that asset class? Is it a certain geography you’re targeting, a certain type of hotel? Just curious, the spreads must be terrific on it.

Michael Comparato: Yes. I would say overall, hospitality is performing exceptionally well, certainly within the leisure aspect of that space. I think we’ve seen across the board, a lot of leisure-oriented hotels surpassing their performance of 2019, which was all-time highs. And I think as you look across kind of all travel segments, whether it’s TSA checkpoints, whether it’s airlines that are recording record revenue, everybody on this call has probably stayed in a hotel in the U.S. in the past 6 to 12 months. The rates are mind blowing. So the hotels really have pricing power right now and are doing exceptionally well, again, specific to the leisure-oriented space. I think the business traveler and certainly the convention center hotel is an area that we will continue to avoid.

It’s recovering, it’s moving the right direction post COVID, but it is not anywhere close to recovering to full COVID levels. And I’m not sure that we will ever see that take place. If you were the generic salesmen that went to see your client 4 times a year, you’re probably not seeing them 4 times a year anymore. You’re probably seeing them once or twice and the other once or twice are going to be, by some means of virtual conference. So I just think that COVID, Zoom, Teams, all of these video conferencing innovations that we’ve had have probably forever changed the business traveler and the office industry overall. So our focus has really been on leisure-oriented and nonbusiness traveler hotels, and they’ve done really, really well.

Matthew Howlett: Makes a lot of sense. And I’ll sneak one more question in, if you don’t mind. The modifications you did in the quarter, you said it clearly improved the quality. So assuming there’s an equity contribution and just go over again what are the terms for gaining modification?

Michael Comparato: Yes, no problem. I think we’ve long held going back to the beginning days of COVID that we’re going to try to be an accommodative lender through what we all acknowledge is difficult times, but that starts with a conversation reminding borrowers that we are their lender and they’re not — we’re not their partner, right? When equity investors, 2x and 3x their equity in the good times, I’ve yet to get the call from the borrower saying, “Hey, we want to pay you a little extra, because we did so well.” The same thing works on the way down. We just have to say it gently. But our expectation is, if you’re looking for accommodations from us, that usually involves showing up the discussion with your checkbook. We want to be problem solvers.

We want to fix assets, but it’s not going to be a one-way street where it just fixes things for the borrower, we want to improve our credit position and our credit quality. So that’s the mindset that we have throughout the organization as we walk into a modification is, be reasonable, be respectful, understand the other side’s situation. But at the end of the day, our duty is our — to our shareholders, and we need to make our credits incrementally better than they were before that conversation started. And that can mean a myriad of things from paydowns to getting recourse to getting better covenants like there’s many different tools in that toolbox.

Operator: As we have no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks.

Lindsey Crabbe: Thank you for joining our call today. Please reach out if you have any further questions. Thanks again.

Operator: This concludes our presentation. Thank you for joining. You may all now disconnect.