BrightSpire Capital, Inc. (NYSE:BRSP) Q4 2022 Earnings Call Transcript

BrightSpire Capital, Inc. (NYSE:BRSP) Q4 2022 Earnings Call Transcript February 21, 2023

Operator: Greetings and welcome to the BrightSpire Capital Inc. Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, 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 2022 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 end over the call, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management’s current expectations and 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-Q 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, 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 reconciliation 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 of our results. The company reported fourth quarter 2022 GAAP net income attributable to common stockholders of $4.2 million or $0.03 per share, distributable earnings of $34.2 million or $0.27 per share and adjusted distributable earnings of $35 million or $0.27 per share. The company also reported GAAP net book value of $10.77 per share and undepreciated book value of $12.06 per share as of December 31, 2022. With that, I would now like to turn the call over to Mike.

Mike Mazzei: Thank you, David. Welcome to our fourth quarter and full year earnings call and thank you for joining us today. Over the last year, we have been very vocal about the impact of the Fed’s aggressive tightening policies. Therefore, today, I will keep my market comments brief. And I will address current dynamics affecting the office sector and then turn the call over to Andy who will provide more detail on asset management developments and our balance sheet. Early last year, we decided to not fight the Fed and made a strategic pivot to a risk-off mode. We substantially throttled back on loan originations in order to prioritize liquidity. We turned inward to focus on asset management and engaging with all borrowers. We made certain to apprise them well in advance of the significant increases in interest rate cap costs and the implications of rising rates on future loan extension tests.

We believe that these early actions in 2022 helped us to get ahead of the curve. Turning to 2023, BrightSpire’s strategic direction will somewhat hands on how long the Fed maintains its restrictive policies. The expectation is for the Fed to increase rates another 25 basis points in March and again in May. So, while the rate increases are substantially behind us, the number one question for 2023 is just how long does the Fed mean when it says higher for longer? We believe that outside of a panic event, higher for longer means through the end of this year. And for what it’s worth, we also believe that the Fed will need to change its 2% inflation target. Therefore, as we navigate through this uncertain period of Fed policy, we continue to emphasize maintaining higher cash balances and proactively managing our loan portfolio.

Regarding our liquidity, as of today, we have $284 million in unrestricted cash and $449 million of total liquidity. Now turning to the capital markets, there have been some green shoots in the CRE CLO market, which has seen two securitization issuances thus far this year. The most recent issuance was met with significant investor demand and albeit while pricing improved from Q4, it’s still wide and the transactions do not yet allow for a reinvestment period. There has been continued tightening of credit spreads in both the corporate bond and CMBS securitization markets. Therefore, we expect to see more follow-on improvements in CLO credit spreads and deal terms through the course of the year. Now, I would like to discuss the office property sector.

We believe this is a more significant issue in commercial real estate than high current level of interest rates. While rates will inevitably come down and benefit all property types, the headwinds in the office sector are longer term and in some cases could be more permanent. The work-from-home model, whether full-time or hybrid, has become the new normal. This is impacting all types of private businesses as well as federal and state government agencies. This is also having a concerning impact on city and state sales tax and transit revenues. The major tracking tool for the industry has become office attendance data, while slowly improving office attendance is generally tracking an average of only 50%. There are also significant disparities.

While cities in Texas are experiencing office attendance in the mid-60s, the San Francisco Bay Area and Washington DC are both in the low-40s. In addition, the attendance rates are consistently concentrated midweek. Even New York City is now considering a work-from-home model for its municipal office employees. And all of this is even further complicated in certain large metro markets, where quality of life issues along with higher income taxes and higher housing costs are adding to employee preferences to work-from-home and whereby home has too often become a completely different state than their employer. These dynamics are creating leasing headwinds and asset valuation uncertainties that have also culminated into a risk-off environment by lenders who become substantially frozen from making new loans on office properties.

In fact, most lenders are now focused on managing office loan exposures in their own portfolios. Shifting to BrightSpire, we took into consideration these work-from-home factors in our post-COVID office loan originations. We focused on drive to work markets, office properties with diverse rent rolls as well as lower average loan sizes. Portfolio granularity was a major consideration for our strategy. We contemplated the liquidity and dry powder that theoretically might be required, should there be a need to protect the balance sheet for larger multi $100 million loans. We believe that boxing in your designated weight class for loan sized concentrations is a critical part of risk management. Hence, our average new office loan size was $32 million.

We further recognize that our loans are non-recourse and that even large institutional borrowers have financial limits and in the end we will act in their own economic self interests. In closing, we are very pleased with our 2022 results, which reflect our team’s ability to quickly pivot the business in a fast changing market. We closed the year with both solid earnings and increased liquidity. BrightSpire is positioned to be opportunistic once we have better visibility. In fact, some of the best lending opportunities will be in the office sector. In the meantime, all things being equal, our bias continues to remain toward maintaining higher levels of liquidity versus making new loans. With that, I would now like to turn the call over to our President, Andy Witt.

Andy?

Andy Witt: Thank you, Mike and good morning everyone. During the fourth quarter, our focus remained on asset liability management. We received $383 million in repayments and partial pay-downs across 12 investments during the quarter compared to $40 million in repayments and partial pay-downs across four investments in the prior quarter. While we are pleased with the increase in repayments and partial pay-downs, we continue to expect loan repayment volume to remain relatively low for the next couple of quarters. During the quarter, we executed on one loan origination which was done in conjunction with a loan recap and payoff. We closed on a preferred equity loan to support the payoff of the largest multifamily loan in our portfolio, which was $182 million and was originated in 2019.

This payoff and recap resulted in a reduction in total exposure and last dollar attachment point from $182 million to its current $22 million preferred position with the last dollar attachment point of $144 million. The senior loan was refinanced with a GSE agency lender and the balance of the payoff proceeds came from borrower equity. Repayment activity during the quarter resulted in loan portfolio decreasing to $3.5 billion from $3.9 billion last quarter. Total at-share undepreciated assets currently stand at $4.9 billion, down from $5.3 billion last quarter, a direct result of negative net deployment. Subsequent to quarter end, there has been $69 million in repayments and partial pay-downs across three investments. As previously highlighted, we anticipated loan repayment volume will remain relatively low over the course of the year.

We expect sponsors will let to or have little choice other than to hold properties longer in anticipation of an improved capital markets environment while continuing to execute on the underlying business plan. Subsequent to quarter end, we had a modification to $116 million office loan, the largest office loan in our portfolio. This modification included the sale of one of the four underlying office properties coupled with an equity contribution from the borrower reducing our exposure to this loan by $29 million. The current balance of the loan post modification has been reduced to $87 million. With interest rates at current levels and trending higher, we anticipate more loan extensions and modifications within the portfolio. As of December 31, 2022, excluding cash and net assets on the balance sheet, the loan portfolio is comprised of 103 investments with an aggregate gross book value of $3.5 billion and a net book value of $977 million or 86% of the total investment portfolio.

The average loan size is $34 million and our risk rating is 3.2. First mortgage loans constitute 96% of our loan portfolio, of which 100% are floating rate and all of which have rate caps. The total portfolio has minimal exposure to construction risk and 74% of the total collateral is located in markets that are growing at or above the national average growth rate. Multifamily, the asset class price buyer has the largest exposure too, consists of 59 loans representing 49% of the loan portfolio, or $1.7 billion of aggregate gross book value. The loan portfolio composition includes 33% office or $1.2 billion of aggregate gross book value. There are 32 office loans with an average loan balance of $37 million. As Mike mentioned, we are acutely focused on the office portion of our portfolio given work-from-home dynamics are greatly impacting certain markets.

Despite these headwinds during the fourth quarter, certain borrowers made critical leasing progress in markets, which include two office loans in San Francisco Proper and one office loan in Baltimore, Maryland. Our office loan portfolio is granular with loan sizes ranging from $12 million to $116 million, which we view as a meaningful risk mitigant. As stated earlier, the $116 million loan was reduced to $87 million subsequent to quarter end. Approximately 58% of our office exposure was originated post-COVID and adheres to the characteristics Mike highlighted. Assets located in high growth, drive to work markets with granular rent rolls and the in-place cash flows. The weighted average occupancy across the portfolio is 72%. The remainder of our loan portfolio is comprised of 12% hospitality, with industrial and mixed-use collateral, making up the rest.

Subsequent to quarter end, BrightSpire made progress on our hospitality exposure through restructuring of mezzanine investment, which included a partial pay-down of the senior loan reducing BrightSpire’s last dollar attachment point. Separately, one hotel property is currently being marketed for sale by the borrower. For your convenience, our 2022 Form 10-K filing includes enhanced loan table aggregations by property type, so investors can more easily review our loan data by asset class. We continue to manage the liability side of our balance sheet through a combination of financing sources, which include warehouse facilities across five primary banking relationships totaling $2.25 billion. As of today, availability under our warehouse line stands at approximately $940 million, which represents a 58% aggregate utilization rate.

Additionally, we have two outstanding CLOs totaling $1.5 billion. At present, approximately 42% of our loan collateral has been contributed to CLOs, 53% is on our warehouse lines and 5% is unencumbered. In summary, it was an active fourth quarter particularly related to asset and balance sheet management. We increased liquidity and addressed some of the largest loans in our portfolio, while increasing earnings quarter-over-quarter. Going forward, we will remain focused on asset management and maintaining higher than normal levels of liquidity. 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 we expect to file our Form 10-K later today. Turning to our fourth quarter results, we reported adjusted distributable earnings at $35 million or $0.27 per share and distributable earnings of $34.2 million or $0.27 per share. Additionally, for the fourth quarter, we reported total company GAAP net income attributable to common stockholders of $4.2 million or $0.03 per share. Quarter-over-quarter, total company GAAP net book value decreased from $10.87 per share to $10.77 per share and undepreciated book value also decreased from $12.08 to $12.06 per share. The decline is primarily driven by a net increase in our general CECL reserves partially offset by distributable earnings in excess of dividends declared and the FX translation related to our Norway office net lease assets.

It’s important to note that while the FX translation did add $0.06 to book value at 12/31, the NOK has since increased in value and would have added only $0.02 using today’s foreign exchange rate. Additionally, we sold our remaining CMBS BP’s investment for $36.9 million during the quarter, a slight premium to carrying value. I would like to quickly bridge the fourth quarter adjusted distributable earnings of $0.27 versus the $0.25 recorded in the third quarter. The quarter-over-quarter increase is primarily driven by the increase in the benchmark interest rates and higher prepayment income related to loan repayments. When adjusting for the full quarterly effect of fourth quarter repayments as well as the beneficial impact rising interest rates continue to have on our portfolio, our adjusted distributable earnings quarterly run-rate is closer to $0.25 per share.

We provide more data in our supplemental financial report, but an illustrative 50 basis point increase in the benchmark rates from the December 31 spot rates would add roughly $4.3 million to our annual earnings or about $0.03 per share. It is also worth noting that halfway into the first quarter, base rates have already increased by approximately 20 bps. Turning to our dividend, in 2022, we generated full year adjusted distributable earnings of $0.98 per share and distributed $0.79 per share for an 81% payout ratio. Looking at reserves and risk rankings, our specific CECL reserves ending the fourth quarter was $57.2 million. No change from the third quarter. Our general CECL provision ending the fourth quarter was $49.5 million, an increase of $20.6 million from the prior quarter.

This mainly reflects an increase in the general CECL for some office and mezzanine loans partially offset by loan repayments and lower reserves on certain hotel loans. Our overall loan portfolio is 99% performing. Two loans, our residential mezzanine loan and an office senior loan moved from a 3 to a 4 risk ranking. Altogether, our average loan portfolio risk ranking at the end of the fourth quarter was 3.2 and the increase in the third quarter is 3.1 risk ranking loans. Our risk rank 5 loans represent 3% of our gross loan portfolio, 2 are the Long Island City office loans with specific reserves taken in the third quarter. The third loan is a performing $12 million hotel loan that was modified during the first quarter of 2023. The fourth one relates to the L.A. mixed use mezzanine loan, which was written off in 2021.

9 loans with an aggregate commitment amount of 17% have a risk score ranking, 4 are office loans and 2 are mezzanine loans. While all are currently performing, we see 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 totaled approximately $4.9 billion as of December 31, 2022. Our debt to assets ratio was 64% and our debt to equity ratio was 2x at the end of the fourth quarter down from 2.3x last quarter. In addition, our liquidity as of today stands at approximately $49 million between cash on hand and availability under our bank revolving credit facility. At present, we believe that $284 million of cash on our balance sheet, in addition to the proceeds available under our revolving line of credit, provide us with the liquidity and flexibility to manage the business.

This concludes our prepared remarks. And with that, let’s open the call for questions. Operator?

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Q&A Session

Operator: Thank you. We have a first question from the line of Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney: Good morning, everyone. Thanks for taking the question. Look, very solid quarter in a obviously challenging market, so good job keeping it heading down the right way. Just curious, heavy repays, that’s always €“ I think in this market that’s a good sign, frankly, because of liquidity, but $383 million can you comment, Frank in terms of the magnitude of prepayment fees associated with that $383 million? Thank you.

Frank Saracino: Sure. I can give you that number if I can find it handy, give me one second, if not, I give it to you. So total prepayment fees for the quarter, I am not going to find it handy, Steve, I am going to have to give it to you. Actually, I have a $1.8 million of prepayment fees.

Steve Delaney: Okay, great. Thank you. That’s helpful. And Mike, just my follow-up question is to you, obviously, really strong dividend coverage where you are at 135%. You made it very clear about the need for liquidity and building liquidity. I think we would all agree that’s necessary in this market. What has your conversations been with the board in terms okay, we are going to keep the dividend where it is, but we need to recognize our stocks trading this morning at like 60% of UTDV . Any thoughts about buybacks and remind me if you do actually have a buyback authorization in place? Thank you.

Mike Mazzei: Hi, good morning, Steve.

Steve Delaney: Yes.

Mike Mazzei: We have said before in terms of buybacks we are prioritizing, defending the balance sheet first and foremost as someone who has worked in credit for my entire career, it’s not the type of message you want to telegraph to our warehouse lenders that we are buying back stock at this time in the market. I think it is much more important that we are telegraphing that we are protecting the balance sheet. So that’s priority number one. In terms of the dividend we have a pretty solid buffer on the dividend. I don’t think right now that there is a conversation going on about raising that dividend, I think that we understand that a lot of that has to do with rising interest rates, with rising interest rates a lot of our brethren talk about that’s great for EPS, I have a more sober view of that and that rising interest rates put more pressure on properties and more pressure on borrower liquidity.

And there is growing credit risk as interest rates continue to go up. So we are going continue to emphasize liquidity. In terms of raising the dividend and stock price right now, all of the market is substantially below their book values. And the market really is saying that there is an issue regarding credit. We want to make sure we understand the credit profile. There has been a lot of movement along the sector in terms of CECL reserve increases a lot of questions about the office sector. So right now, I think the price is really reflecting credit and managing the balance sheet and protecting the balance sheet before it’s looking at are you going to increase your dividend?

Steve Delaney: Yes, no question. I think people are more worried about dividend cuts, then I think you would be wasting your $0.02 or $0.03 to increase it in this market with the skepticism just about the economy and about real estate values. Thank you both for your comments.

Mike Mazzei: Thank you.

Operator: Thank you. We take our next question from the line of Eric Hagen with BTIG. Please go ahead.