Franklin BSP Realty Trust, Inc. (NYSE:FBRT) Q4 2023 Earnings Call Transcript

Franklin BSP Realty Trust, Inc. (NYSE:FBRT) Q4 2023 Earnings Call Transcript February 15, 2024

FBRT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Franklin BSP Realty Trust Fourth Quarter 2023 Earnings 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: Good morning. Thank you, Alan, for hosting our call today. Welcome to the Franklin BSP Realty Trust fourth quarter and full year 2023 earnings conference call. With me on the call today are Richard Byrne, Chairman and CEO of FBRT; Jerry 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 conveyed on this call is current only as of the date of this call, February 15, 2024.

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 at www.fbrtreit.com. We will refer to the supplementary slide deck on today’s call. With that, I will turn the call over to Rich Byrne.

Richard Byrne: Perfect. Thanks, Lindsey and good morning, everyone and thank you for joining us today. I am Rich Byrne. I am Chairman and CEO of FBRT. As Lindsey mentioned, our earnings release and supplemental deck were published to our website yesterday. So, we are going to begin today’s call by reviewing our fourth quarter results and then we are going to open up the call for your questions. I am going to begin on Slide 4. For the year ended 2023, FBRT had distributable earnings for fully converted share of $1.92. This is a 79% year-over-year increase and equates to a 12.1% distributable earnings return on common equity. Our distributable earnings dividend coverage for 2023 for the full year was 135%. In the fourth quarter, FBRT had distributable earnings of $0.39 per fully converted share, representing an almost 10% return on common equity.

Our distributable earnings dividend coverage was 109% for the quarter. Our earnings were modestly lower in the fourth quarter versus the third quarter of this past year. The difference was due to the timing of minimum interest payments. Our portfolio ended the year at $5 billion, reflecting net portfolio growth of $84 million in Q4. We have been steadily originating every quarter throughout 2023. And in total, we originated $818 million of new loan commitments for the year. And our portfolio remains heavily focused in multifamily with 77% of our exposure in this sector. We ended the quarter with $1.5 billion in available liquidity. Unrestricted cash decreased slightly to $338 million due to our net origination activity. With 5% – excuse me, with 5.7% of our total assets in unrestricted cash, we are not just playing defense.

We are actively working to deploy capital. And we are originating very attractive investments that we believe will be meaningfully accretive to our earnings. With many other lenders on the sideline, we have been able to build a robust pipeline, which you will hear more about shortly from Mike. An area we want to provide more details on today is our watch list and general CECL reserve. We ended the quarter with 6 loans on our watch list 3 three loans at the end of Q3. Each watch list loan is rated a 4. Subsequent to quarter end, we took title to one of the watch list loans, and have already liquidated it at a modest gain to our basis, meaning that our 6 watch list loans are now down to 5 or 4.3% of our total portfolio. Mike will provide more watch list detail in his comments, including our definition of how we characterize a 4-rated loan, which maybe more conservative versus many of our peers.

The risk profile of our portfolio is relatively low, with almost 95% of our loans rated 3 or better and an average overall risk rating of 2.3 at the end of the quarter. Our focus on originating newer vintage high-quality multifamily loans continues to deliver stable performance for the vast majority of our portfolio. At quarter end, we held 3 foreclosure REO positions, representing 2% of our total assets. Most of the balance of our foreclosure REO was our Walgreens retail portfolio, which we are marketing for sale. Mike will also provide some detail on our REO positions during his commentary. No asset-specific CECL charges were incurred in Q4, but we increased our general CECL reserve by $5.4 million. Overall, our CECL reserve is 96 basis points of our total portfolio, which we believe is conservative given our portfolio’s strong credit quality and the multifamily focus that we have.

Gary will provide more details on the calculation of our CECL estimate in his section, which we’ll get us to shortly. Finally, FBRT’s buyback authorization had under $36 million remaining at the end of the quarter. We purchased $3.3 million of FBRT common stock during the fourth quarter and $12.5 million throughout 2023. In total, since our program began the company and its advisor purchased $64 million of FBRT common stock. We continue to be active in the first quarter of 2024 of this year repurchasing approximately $1.6 million of our common stock through February 13. Our company buyback is authorized through the end of 2024. Lastly, we are pleased with FBRT’s strong performance in 2023. Our earnings comfortably covered our dividend and produced a competitive risk adjusted return.

And we expect our earnings power to be enhanced as we grow our portfolio in 2024. We remain confident and resilience of our assets in our portfolio. We have ample liquidity and we are singularly focused on delivering long-term shareholder value. With that, I will stop there and I’ll turn things over to Jerry to discuss our financial results. Over to you, Jerry.

Jerry Baglien: Great. Thanks, rich. I am Jerry Baglien, the Chief Financial Officer and Chief Operating Officer of FBRT. I appreciate everyone being on the call today. Moving on to our results. Let’s start on Slide 5. FBRT generated GAAP earnings of $30 million, which is $0.28 per share on a diluted common share calculation. That represents a 7.2% return on common equity in the fourth quarter. Our general CECL reserve increased to $48.3 million this quarter, reflecting an increase of $5.4 million and at $0.06 per share reduction to GAAP earnings. For fourth quarter CECL calculation we adopted a more conservative economic scenario to determine the reserve. The calculation is largely driven by economic conditions in the state of the real estate market.

It is also influenced by the movement of our assets in our internal risk ratings. We earned $39.3 million in distributable earnings in the fourth quarter and a walkthrough of our distributable earnings to GAAP net income can be found in the earnings release. Book value was down in the fourth quarter to $15.77 from $15.82. Our increase to the general CECL provision was a largest driver of this decline, resulting in $0.06 per share reduction to book value. This reduction was partially offset by distributable earnings in excess of our common distributions. Slide 7 summarizes our portfolio progression. As Rich mentioned, our portfolio grew this quarter with our originations outpacing our repayments. However, when looking at the entirety of 2023, our repayments exceeded originations.

This resulted in a modestly smaller portfolio size year-over-year. Despite the smaller portfolio, we are encouraged by the consistency in our prepayments. The repayments speak to the credit quality of our assets and the liquidity in the market for certain asset classes. In aggregate, seven loans were repaid in the quarter. Most of our repayments were for multifamily and hospitality loans, contributing 80% and 15% of the balance, respectively. Slide 8 provides a high-level snapshot of our capitalization. Our average cost of debt during the quarter increased modestly to 7.9%. The increase in our cost of debt is a combination of the issuance of FL10 at the end of the third quarter and the increase in SOFR over the period. 89% of our financing on our core book is non-recourse, non-mark-to-market.

With reinvest available on four of our CLOs and newly issued FL10, we do not have an immediate need to go to market with another issuance. That said, we are always watching the CLO markets and will engage new issuance when the levels are attractive to us. Our net leverage position remained modest at roughly 2.3x this quarter. We are deliberate in our use of leverage and view it as a structural highlight. 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, and I’m going to start on Slide 12. Our portfolio ended the quarter at $5 billion, spread across 144 loans with an average size of $35 million. As Rich mentioned, our exposure is now 77% in the multifamily sector. Our multifamily exposure is in newer vintage assets. Almost one-third of our multifamily exposure was built between 2020 and 2023. 40% of our exposure was built between 1990 and 2020. Importantly, our exposure is in population centers with meaningful employment basis. Across our entire portfolio, the weighted average five-mile population size is approximately 240,000 people. There has been talk in the market about current weakness in multifamily properties.

We continue to believe this weakness is more a reflection of overleveraged borrowers likely taking losses on late 2021 and early 2022 acquisitions and is not reflective of weakness at the asset level. In other words, it’s a story of good assets and broken balance sheets. While there will be equity losses in multifamily, I do not believe FBRT is likely to experience any meaningful losses in our current multifamily book. To be clear, that view is in the context of a 425 10-year treasury yield. In addition, we have an integrated equity asset management team and believe we may even have the opportunity to turn some potential future REO situations into profitable transactions over time. We are long-term bullish on the fundamentals of multifamily at the asset level, and we’ll continue our focus on our portfolio originations on newer vintage assets and larger market.

There continues to be an exceptional amount of liquidity in the multifamily market as evidenced by the robust levels of repayments that we have been receiving and by the endless inquiries we are receiving from investors looking to acquire loans as a mean to obtaining title. This liquidity was especially evident in a transaction that recently went into maturity default. After an extensive negotiation to extend alone, a borrower offered an unexpected deed in lieu of foreclosure last December. We made five phone calls to local market participants, all who are extremely interested in acquiring the property. One investor even offered to sign a PSA that week with a nonrefundable deposit. Conversations like these rarely occur in any other asset class within the commercial real estate universe.

We took title to the property and less than a week later, closed on the disposition at a price above our outstanding balance. Slide 13 highlights our origination activity specific to the fourth quarter. We originated seven loans at a weighted average spread of 391 basis points. These transactions were primarily in multifamily and hospitality and were located across the Sunbelt. Turning to 2024. We’ve seen transactional volume pick up across multiple product lines. We expect to see substantially more transactions in the middle market. Competition remains thinned out and the regional bank bid has not returned. Quarter-to-date, FBRT has committed to $155 million of new loans and funded $122 million. We anticipate funding another $78 million tomorrow and have a robust pipeline through the remainder of the quarter.

We are also seeing green shoots in the conduit market, which has historically been an earnings enhancer. In Q1 of 2024, we project to generate approximately $3 million in conduit revenue, which would be our highest quarterly conduit revenue in over two years. CMBS has again become one of the lower cost financing options in the market, so we are cautiously optimistic that conduit revenue could pick up in 2024. Borrower behavior remains difficult to predict. We are being proactive in getting ahead of issues with our borrowers and are in constant contact with borrowers where constant contact is needed. Our real estate team’s experience is deep and is equipped to handle a wide range of outcomes. We’ve been successful in resolving loans and extending or modifying when appropriate.

In the fourth quarter, we modified 13 loans. 10 of those 13 modifications, the borrowers contributed additional equity and in 8 of those 13 modifications, we were able to reduce our total loan exposure. We will continue to be laser-focused on improving our existing book when the opportunities present themselves. Even though we already have one of the lowest office loan exposures in the industry, we continue to shrink that exposure. We received one full office repayment in Q4 and another in early January of this year. Excluding our long-term net leased corporate headquarters and distribution facility, our office exposure is now comfortably under 5% of the portfolio. Moving to Slide 14, you will see a summary of our watch list activity. We ended the quarter with six loans on our watch list, all 4 rated with an aggregate GAAP value of $272 million.

As already mentioned, one of those six has been fully repaid and resolved. Risk ratings vary company to company, and we review our entire portfolio every quarter and rerate each loan. Certain characteristics warrant us rating a loan a 4. Our quarterly and annual filings define each investment rating, but for the purpose of our current watch list, I’ll describe a 4 rating. For us, a 4-rated asset is one that is an underperforming investment with the potential of some interest loss, but still expecting a positive return on investment. Trends and risk factors are negative, but it is not indicative of expected loss in a future loss to our basis. During our quarterly review process in the fourth quarter, loans were downgraded to a 4 based on the measurements I just described.

However, today, we already have positive updates on several of those loans. The six loans on our watch list are a CBD high-rise office building in Denver, Colorado. This loan was added to watch list in Q3 of 2023, and we are in the process of amending this loan with the borrower. We also have a Class A office building in Alpharetta, Georgia. This loan was added to watch list as well in Q3 last year. We have reduced our basis on this asset meaningfully in 2023 and recently entered into another loan amendment, which included additional repayments on principal. We have a 279 key hotel in Dallas, Texas. This loan was added in Q4. It has since been extended and is being actively marketed for sale. The 352-unit apartment community in San Antonio is one we previously mentioned.

This asset was sold yesterday at a gain to our basis and therefore, will be removed from watch list. We have a 471-unit apartment community in Raleigh, North Carolina that was added in Q4. We are in active dialogue with the borrower, and we have received extensive interest from the market to acquire the loan at par. And lastly, a two-property apartment portfolio in Mooresville and Chapel Hill, North Carolina, this loan was lastly added in Q4, and we are in active dialogue with the borrower and reviewing potential options. Our total foreclosure REO positions at quarter end stood at three. As we discussed on our last call, one asset was removed from our watch list in Q4 and taken as REO. This is a small multifamily position in Lubbock, Texas.

Our asset management team has meaningfully improved the asset quality in a short period of time and the property has positive leasing momentum. It is currently held for investment as we improve the asset. The other two assets remaining as foreclosure REO are the Portland office building and the Walgreens portfolio. As it pertains to the Portland office property, we received a meaningful payment from one of the property tenants. However, big picture, we do not believe exiting the asset in the current market environment for office buildings is the proper decision. Lastly is our REO Walgreens portfolio. We did not sell any stores in the fourth quarter. Our intention remains to liquidate the portfolio as the market permits, but we are not for sellers.

We are comfortable holding these assets until we reach pricing levels that we feel are appropriate. In aggregate, our foreclosure REO balance ended the quarter at $122 million, which is approximately 2% of total assets. In closing, it’s clear that our industry is dealing with significant headwinds. However, we are actually quite bullish about the market opportunity for FBRT right now given our substantial liquidity position and our limited office exposure. Also, we remain confident in the continued outperformance of our existing portfolio, given our relatively outsized exposure not only to just multifamily, but newer vintage, higher quality multifamily in larger liquid markets. We believe this will provide us with a competitive advantage in 2024 and continue to play offense when most other lenders are on the sidelines.

With that, I would like to turn it back to the operator to begin the Q&A session.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Sarah Barcomb of BTIG. Please go ahead.

Sarah Barcomb: Hey, good morning, everyone. So, I just wanted to narrow in on the San Antonio foreclosure. I think the key takeaway here is that you guys got a full recovery. But can you talk a bit more about what led to sponsors walk away here and how you might view this property differently compared to the broader multi-portfolio? This is a higher LTV peak of Sunbelt multifamily cap rates vintage assets. And that new valuation you disclosed implied nearly a full equity wipe out. Is this a standard outcome for an asset like this where maybe you get the keys back but at the senior mortgage lender basis, you see a full recovery. And I’m also curious if you think this could represent a peak to trough valuation for this cycle? I’d appreciate any color there. Thanks.

Michael Comparato: Hi, Sarah. Good morning. Thank you for the question. This was a fairly frustrating process, but as you alluded, all is well that ends well. I do think it’s representative of a lot of transactions that closed in late 2021 and early 2022. The borrower had an extension option and the only condition to exercising that extension was buying a new interest rate cap. They told us they were going to buy a new interest rate cap, then they told us they weren’t going to buy a new interest rate cap. They offered us a proposal, we negotiated a proposal. They agreed to the proposal and then when all was said and done, they couldn’t raise the additional money from their LPs to move forward at all. So, it was very surprising to us.

But as I’ve talked about for several quarters and even again today, borrower behavior it’s very, very difficult to predict. So as frustrating as is for you guys, it’s frustrating for us as well. But again, we took the asset. These assets are very liquid right now in the market, and we’re able to sell it for a gain. But generally speaking, yes, I do think this is probably representative of what we will see for those late 2021, early 2022 acquisitions where, again, as I alluded to in my comments today, I don’t foresee us having any meaningful losses in the multifamily book given where the market is today. I think if borrowers elect not to move forward and extend or continue their business plans, I believe we have the ability to move most of our positions above our current debt basis.

Sarah Barcomb: Okay. Great. And then – and you’ve already touched on this, but my follow-up is related to that risk rating migration. You’ve repeatedly highlighted before this call as well that borrower behavior is very difficult to predict. So, we recover that full basis, we saw this migrate from two in Q3 through a foreclosure in this spring. Can you just talk about how you’re thinking about risk rankings going forward?

Michael Comparato: I mean it’s an imperfect world, right? And it’s an imperfect illiquid asset class. So, the only information we can gather is the actual quantitative data at the property level and then our conversations with the borrower. They had been implementing the business plan. They were renovating units. They were improving the asset. They were doing the things that they told us they were going to do – and as always, our asset management team engaged with them probably four to six months in advance of their loan maturing. And every conversation was we’re moving forward, we’re moving forward. We’re going to amend, we’re going to do what we need to do. And it was literally days before maturity. We had a fully negotiated documented extension papered with the attorneys, and they just called us a few days before and said, can’t do it.

So, I’m not sure what we could do differently within the context of that set of facts. I think we’ve got a very good process. I believe our rankings are as accurate as they can possibly be given the information we have, and we will just continue to do our best to give you guys as much transparency as we can.

Sarah Barcomb: Yes. Yes. No, I appreciate the color there. Again, it’s good to see this come back as effectively a full repay. So thanks for taking my questions.

Operator: Thank you. The next question comes from Stephen Laws of Raymond James. Please go ahead.

Stephen Laws: Hi, good morning. First, I want to thank you for the detail and the color on the watch list in REO. It’s nice to have that level of discussion. One follow-up on Sarah’s question around San Antonio. I know you’re able to exit it at your basis. Can you talk about what the original loan balance was? And then did you provide financing to the new player? And if so, what type of LTV did you look at on the new valuation as far as setting the new loan?

Michael Comparato: Hi, Stephen, good morning. Thanks for the questions. I’ll start backwards. So yes, we did provide financing to the new buyer. Their anticipation is to flip this to agency financing very quickly. The asset was largely stabilized. I think it was like 92% leased or 93% leased for the past few months. So, we provided just a 1-year acquisition facility of $38 million roughly or maybe $36 million to $38 million in that range. And it was just a 1-year loan fixed at 9% with a 1 point origination fee. So, we thought, based on how much interest there was in the asset at the $43 million level. We felt very good back another 10 to 15 points on only one year of exposure. And it’s a very, very top shelf middle-market operator, who we historically have not provided financing to. So, we are very happy to also get a new client out of the opportunity. And I apologize, Stephen, what was the first part of the question again?

Stephen Laws: The original loan balance as far as opposed to I think you provided the carrying value, but the original loan balance.

Michael Comparato: I believe it was about $1.5 million back of where our ending balance was. I think we had about $1.5 million in future fundings to effectuate the business plan.