Q3 2023 Lument Finance Trust Inc Earnings Call

Participants

Andrew Tsang; IR; Lument Finance Trust, Inc.

James Flynn; CEO; Lument Finance Trust, Inc.

James Briggs; CFO; Lument Finance Trust, Inc.

James Henson; President; Lument Finance Trust, Inc.

Zachary Halpern; Senior Director, Porfolio Mangement & Capital Markets; Lument Finance Trust, Inc.

Stephen Laws; Analyst; Raymond James

Steve Delaney; Analyst; JMP Securities

Matthew Erdner; Analyst; Jones Trading

Christopher Nolan; Analyst; Ladenburg Thalmann

Presentation

Operator

Good morning, and thank you for joining the Lument Finance Trust's third quarter 2023 earnings call. Today's call is being recorded and will be made available via webcast on the company's website.
I would now like to turn the floor over to Andrew Tsang with Investor Relations at Lumen Investment Management. Please go ahead.

Andrew Tsang

Thank you, and good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust's third quarter 2023 financial results. With me on the call today are James Flynn, CEO; James Briggs, CFO; James Henson, President; and Zachary Halpern, Senior Director of Portfolio Management. Yesterday, on Monday, November 13, we filed our 10-Q with the SEC and issued a press release to provide details on our third quarter results. We also provided a supplemental earnings presentation, which can be found on our website.
Before handing the call over to Jim Flynn, I'd like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
When used in this conference call, words like outlook, evaluate, indicate, believes, will, anticipates, expects, intends, and other similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Forms 8-K, 10-Q, and 10 K and in particular, the Risk Factors section of our Form 10-K.
It is not possible to predict or identify all such risks. Listeners are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements. Furthermore, certain non-GAAP financial measures will be discussed in this conference call.
Presentation of this information is not intended to be considered in isolation nor as an substitute for financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.
For the third quarter, we reported GAAP net income of $0.1 per share, while distributable earnings were $0.11 per share. In October, we paid a dividend of $0.07 per share with respect to the third quarter, which represented approximately 17% quarter-over-quarter increase.
I will now turn over the call to Jim Flynn. Please go ahead.

James Flynn

Thank you, Andrew. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the third quarter of 2023. We appreciate everyone joining today. The macroeconomic environment continues to be a challenging one, a mild recession beginning in the first half of 2024 remains a possible outcome as higher for longer rate environment seems to be the consensus, economic forecast. Given the surprising resiliency of the labor markets, consumption continues to outpace incomes, and government spending, and interest cost concerns.
As we await the impact of the recent and dramatic monetary policy tightening to fully work its way through the system, we are also faced with heightened geopolitical uncertainty further modeling the near-term outlook. Given the interest rate volatility, multifamily and other commercial real estate property types continue to trade thinly. Overall, US commercial real estate investment sales volume was down greater than 50% year over year in Q3.
Despite deceleration of rent growth and widening of year over year cap rates, multifamily continues to be the preferred sector and is supported by strong fundamentals. While deliveries are elevated in certain markets this year and next, muted new construction starts suggest limited supply in the medium term, which is supportive of higher asset values as we move forward. Demand for multifamily continues to be driven by historic homeownership affordability gap, of prices of single-family homes remaining high, and residential mortgage rates currently north of 7%.
Given these positive signs in the long term, LFT remains committed to its investment roots in seeking middle market multifamily investment opportunities that are accretive to the earnings and long-term shareholder value.
The CRE CLO market continues to see significant dysfunction with only two [manners] CRE CLO transactions, price during the third quarter and year to date. Issuance volumes through October are down 66% year over year from a already depressed prior year.
Given the uncertainty in the capital markets, we are proud to have successfully executed on July 12, a $386 million floating rate mortgage portfolio financing transaction that we will subsequently reference as LMF 2023-1. In connection with LMF 2023-1 transaction, $270 million of an investment grade rated senior secured floating rate loan was placed with the private lender and approximately $47 million of investment grade notes were issued and sold to an affiliate of our external manager.
LFT retained $67 million (sic - see slide "$68.6 million ") of subordinate notes in that transaction. The outstanding liabilities of this financing transaction have an initial weighted average spread of 314 basis points over 30-day term SOFR, excluding fees and transaction costs. The initial collateral pool consisted of 21 -- 25 first lien floating rate mortgage loans secured by 32 multifamily properties located across the United States. The majority of the collateral was acquired from the affiliate of the manager at an aggregate discount to par of approximately 1.5%.
The weighted average spread of the initial collateral was approximately 365 basis points over 30-day term SOFR, which we estimate works out to an effective spread on the initial collateral pool north of 425 basis points. LMF 2023-1 provides for a 24-month reinvestment period that allows principal proceeds from repayments of the mortgage assets to be reinvested and qualified replacement mortgage assets subject to certain conditions.
Consummation of this financing allowed the company to increase its investment capacity to approximately $1.4 billion at a relatively attractive incremental cost of capital. With the closing of LMF 2023-1, coupled with our CRE CLO debt previously issued in 2021 and an outstanding corporate term loan, which matures in 2026, the company currently maintains an attractively priced and elongated liabilities profile. That positions us well as we enter an uncertain part of the market cycle.
LFT's investment strategy of acquiring floating-rate mortgage asset position positions it well for a higher for longer rate environment. We believe the company consistently differentiates itself from its peer group through its continued focus on middle-market multifamily credit opportunities, its culture of active asset management, and its strong sponsorship from the broader ORIX platform.
With that, I'd like to turn the call over to Jim Briggs, who will provide us details on our financial results. Jim?

James Briggs

Thank you, Jim, and good morning, everyone. Last evening, we filed our quarterly report on Form 10-Q and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. Supplemental investor presentation has been uploaded to the webcast as well for your reference. On pages 4 through 7 of the presentation, you'll find key updates and an earnings summary for the quarter.
For the third quarter of '23, we reported net income to common stockholders of approximately $5.2 million, or $0.10 per share, for a few items I'd like to highlight with regard to the third quarter P&L. Our Q3 net interest income was $9.5 million compared to $7.5 million in Q2, primarily as a result of the growth of our loan portfolio facilitated through the execution of the LMF 2023-1 financing transaction in July.
SOFR increased 23 basis points during the quarter from [5 spot 9%] to 5.32%, driving an increase in the interest income on our portfolio in excess of the increase in the cost of our floating rate liabilities. Exit fees and other prepayment related income were relatively flat sequentially, despite payoffs being higher than prior quarter due to a larger portion of the multi-family payoffs this quarter being refinanced with agency debt provided by an affiliate of the manager. Note that in such situations, a portion of the managers expense reimbursements are waived pursuant to the terms of the management agreement.
Our total operating expenses were $2.4 million during Q3 versus $4.4 million in Q2. This quarter over quarter decrease was driven primarily by the $1.7 million or $0.03 per share of deal costs we expensed in Q2, and which had been incurred in pursuit of executing a broadly marketed CRE CLO securitization transaction which we ultimately abandoned in Q2 in lieu of the more attractive LMF 2023-1 private financing transaction.
For Q3, we reported distributable earnings of approximately $6 million or $0.11 per share. The primary difference between reported net income and distributable earnings was the approximate $800,000 net increase to CECL general reserves in the quarter, primarily due to the increase in the overall size of the floating rate loan portfolio as well as changes in the macroeconomic forecast in the periods.
As a non-cash unrealized items, these charges are adjusted out for purposes of calculating distributable earnings. We did not take any asset-specific provisions in Q3. As of September 30, the company's total equity was approximately $241 million. Total common book value was approximately $180 million, or $3.46 per share, up $0.03 per share from Q2. We ended the third quarter with an unrestricted cash balance of $43 million. We also had an additional $30 million of aggregate reinvestment capacity through our two secured financings.
I will now turn the call over to Jim Henson to provide details on the company's investment activity during the quarter and portfolio performance. Jim?

Operator

Pardon me. This is the conference operator.
Mr. Henson, is it possible your phone is on mute?

James Henson

Yes. Thank you. Thank you, Jim Briggs, and thank you. I will now provide a brief summary of our recent activity within our investment portfolio. During the third quarter, we experienced a net $341 million increase in our loan portfolio after accounting for a $111 million of loan payoffs. The $111 million of loan payoffs experienced during the quarter represented approximately 33% annualized payout rate, which is relatively in line with the long-term historical averages and our short-term expectations.
Of the $452 million of loan investments acquired or funded during the quarter, 99% are collateralized by multifamily properties. Loans acquired during the quarter from an affiliate of the manager were acquired at an aggregate discount to par of $7.1 million. As of September 30, our portfolio consisted of 87 floating rate loans with an aggregate unpaid principal balance of approximately $1.4 billion, of which 93% was collateralized by multifamily properties.
100% of our portfolio rate -- that floating rate portfolio is indexed to one-month SOFR. Our investment portfolio performed well. We ended the third quarter with 75% of the portfolio risk rated a 3 or better, and we have maintained a weighted average risk rating of 3.4 quarter over quarter.
Several offsetting factors impacted the average risk rating for the quarter. On one hand, the average risk rating would have shifted toward improvement during the quarter due to the company acquiring four new 2 rated loan investments with an aggregate unpaid principal balance of $64 million and two existing loan investments totaling $31 million of unpaid principal balance moving to a 2 rating during the quarter due to improved property performance metrics.
In addition, several assets migrated from a 3 to a 4 rating and two loan assets migrated from a 4 to a 5 rating. We had 300 investments, each collateralized by multifamily property, which were rated a 5 for the third quarter. These loans with an aggregate unpaid principal balance of $69 million are currently considered collateral dependent due to actual or expected monetary default.
One of these three loans we have discussed in prior quarters, and we continue to pursue all available remedies with regard to that loan. After conducting our analysis of the underlying collateral, we have conclude -- we have not recorded any specific reserves with respect to these investments. We continue to proactively monitor the health of our portfolio, and we rely on the depth and breadth of our managed capabilities to drive positive asset management outcomes while protecting shareholder value.
With that I will pass it back to Jim Flynn for some closing remarks.

James Flynn

Thank you, Jim Henson. Appreciate everyone's time and interest. I want to open the call up for questions. I know there's a few already in the queue.

Question and Answer Session

Operator

(Operator Instructions)
Stephen Laws, Raymond James.

Stephen Laws

Hi, good morning. Let's start with the three multifamily loans. Can you give us some details kind of where the -- they should talked about one before, but where are they located? Are they look the with same borrower different sponsors there? And what's the timeline and kind of resolving that and recycling capital to performing investments?

James Flynn

So I will let Zac Halpern talk on the details. They're all different sponsors, all different locations, and in different stages of underperformance. But as Jim pointed out, we still feel comfortable that we're going to be repaid on the collateral. But we're working with the borrower. They all have different issues.
And so I'll let Zac give you the high level of kind of generally where they are. But one is primarily a partnership dispute, one is behind this business plan, and one had significant issues at the physical property and is working through proceeds on insurance, et cetera. Zac, you want to go ahead and give a high level?

Zachary Halpern

Sure. So the asset that we've been talking about for the last three quarters is in Ohio. The asset -- there is another asset in Virginia that's the one that's in partnership dispute. And then there's an asset in Florida that's behind on this business plan. When we consider all three assets and look at them and sought information on that and site visits, et cetera. We find that with the exception of the first asset, which [but that shouldn't do that -- it shouldn't be we're] pursuing legal revenues on and also do not expect a loss.
The other two -- while there is some monetary issue, the loan is -- appears to be lower than the value at present. And we'll borrowers/sponsors with incentive to securities and work towards resolution and therefore we're not expecting losses at present.

James Flynn

So on -- and you had asked, Stephen, on the type -- one, there are payments being made there in variety of ways, paying down principal, paying down -- paying interest late, those kinds of things. The timeline is, as you know, there's some uncertainty to it all, but we're certainly expecting these to be resolved in the next couple of quarters is kind of how I'm looking at it at least one or two of them and maybe all three.
But for better or worse things sometimes seem to take longer. For example, the partnership dispute is really -- it's impacting us as lender, but it's an issue between the owners and they have to settle their own dispute. And then I think we would be ready to move forward likely through a sale or whatever we decide to do. So we're pursuing our remedies to push them to get to their conclusion, so some of that is an example of just working through the legal process. But hopefully first half of '24 events, but it could be longer.

Stephen Laws

Sure. That sounds like it's unique issues at each asset. Not anything that's --?

Zachary Halpern

Correct, it's not a (multiple speakers).
The other thing I'll mention is that these two assets are within the securitizations whose reinvestment period is ending and there's not too much we can do near term anyway, even if we payoff to redeploy capital, like it's --. We're going to have to deal with that securitization in probably 2024. It's not like we're losing investment capacity.

Stephen Laws

Understood. And then the take on a nonaccrual in the quarter, were they in interest income for the full 3Q or did some of them only contribute for partial or none of the quarter?

James Briggs

We reversed out when we put it nonaccrual around $300. As Jim mentioned, we talk in our filing about them being on a cash basis. So we are seeing some payments there, which will reflect an income as we get it. It was around [$300] of income that got reversed in the quarter.

Stephen Laws

Okay. Helpful. Great. Appreciate the time this morning. Thank you.

Operator

Steve Delaney, JMP Securities.

Steve Delaney

Thanks. Good morning, Jim. Jim, and Jim. Jim Flynn, the portfolio, it's $1.3 billion, about 4.5% debt to equity. Do you consider Lument's portfolio to be fully invested currently based on your capital base? Thanks.

James Flynn

Yes, thanks, Steve. Good to hear from you. We have -- so the answer is yes, it's around [$1.4 billion] is the total capacity give or take. Obviously we want some cash, we have a couple of assets that we've discussed. But generally speaking, it's upwards of [$1.3 billion and close to $1.4 billion].
We're obviously where we have -- as loans work themselves out and things like that we've generally kind of made the decision to maintain the liquidity. We elevated liquidity for obvious reasons. But that's the kind of mass of our portfolio today as we've discussed many times, obviously, we want to think about growth. But right now, it's really focused on our portfolio, asset quality, working with sponsors, making sure that we're positioned to take advantage of the market as it improves down the road here.

Steve Delaney

That's helpful. I mean, we really are in a market, it would seem would emphasize quality over quantity at this point, kind of wait and see. So the net interest income that you had, $9.5 million, it was I think $7.5 million in the prior quarter. And I realize, repayments you get acceleration. Is there anything in that $9.5 million that you would point out to be materially large one-time accrual of revenue that you had on or did either discount or deferred fees that you had on the books?

James Flynn

Jim, you want to go ahead on that?

James Briggs

Yeah. No, I wouldn't say there's anything one-timer in there. As we talked about the economics around prepayment and fees there. We're relatively flat quarter on quarter. Some of that is coming through a reduction in expense reimbursements. But I don't consider there to be anything material in there, Steve.

Steve Delaney

Okay, great. And then just one final point. The $7.1 million that you pointed out discount specifically to LMF 2023-1, should we look at that -- I know those loans were already originated, which would a three year average life would that be a reasonable approach to accreting that money into the net interest income?

James Briggs

Yeah, I think that's reasonable, Steve, three year. Yeah.

Steve Delaney

Okay. Well, great quarter and good job on the big financing and we'll look forward to fourth quarter. Thank you very much.

James Briggs

Thanks, Steve.

Operator

Matthew Erdner, Jones Trading.

Matthew Erdner

Hey, good morning, guys. Thanks for taking the question. So could you just talk a little bit about what the opportunities you're seeing out there currently? I know you that you guys focus on multi-family, but can I just get an idea of what you guys are looking at the moment and just the health of the pipeline. Thanks.

James Flynn

Sure, look I mean, the opportunities are less than they've been in prior quarters, as we've discussed, just in terms of transaction volume being so significantly down. So assets aren't trading hands so that opportunity has significantly declined. But so have lenders and lenders that are either can or willing to make new loans. So when we have seen assets come in, we are looking at, generally speaking, more conservative looking underwriting, lower leverage, high-quality sponsors.
It does have an impact, I think with rates being so high spreads have kind of stabilized around 4%, but you've seen a lot of pressure on that -- I'm sorry spread before, but I think you'd see a lot of pressure on that to be lower when you've gone with a very low levered bridge loans and kind of pushing things down closer towards 3% for those high-quality loans. I think you'll see lenders probably take a look at those deals and trade a little spread for risk or low risk.
In terms of some of the things we've talked about in the past around subordinate debt opportunities, around mezz financing, preferred equity, et cetera. There's a lot of market chatter around those particular products. There's a lot of lenders and people looking to participate in that market, including us both at LFT and in our broader platform. The reality is that there's not a tremendous amount of deals that that works for today given where the rates are expected to be for that product in the teens, mid-teens, even. And it is hard to replace your prior debt capital if you're kind of refinancing something with the mid single digit with 2x on preferred.
And so there's just I think that we haven't yet seen kind of the dam break so to speak of transactions I think as values -- buyers and sellers kind of accept values, the spread between buyers and sellers narrows, I think we're going to see more opportunity for new loans for bridge for bridge transactions that are kind of moving -- finishing off a prior strategy at a different cap stack, transitioning some of these assets that are being delivered off of construction loans to lease up bridge loans.
And I think you'll see opportunities both on the bridge space. It's not going to be 2020 or 2019, but I do think we'll see some opportunity increase. And I also think that other space of mezz capital, as you start to see actual transactions, assets changing hands, it will be more opportunity there. But we really need that transaction flow to pick up. I mean for that, I think we need buyers and sellers too, except where values are and come to a agreement narrow gap and then we'll see some of those opportunities.
And as we noted, we retained some of the low investment grade rated bonds in our last transaction. And that was because of it was an attractive spread. So there's -- there might be some opportunistic trades in the secondary market for some of these CLOs that are out there. But that's going to be very portfolio specific.

Matthew Erdner

Got it. Thank you. That's good color there. I appreciate that. And then on the recent CLO, I don't know if you mentioned it or not, but is there a reinvestment period? And then if there is, when does that expire and how much of it is open at the moment? Thanks.

James Flynn

It's two years. And to be clear, I may have said CLO, but it's a financing transaction, it's not technically a CLO just to clarify. But it is a very similar structure, and it has a two-year reinvestment period.

Matthew Erdner

Thank you.

Operator

(Operator Instructions)
Christopher Nolan, Ladenburg Thalmann.

Christopher Nolan

Jim Briggs, just a clarification. Were there any nonrecurring expense items in the quarter?

James Briggs

No, nothing unusual or one-timer. As I pointed out, we did have the big one-timer last quarter for the deal costs for widely distributed public CLO that we expensed in Q2. But nothing I would consider one-timer in the current quarter.

Christopher Nolan

Great. And then I guess some [for] just depend on general. Any change in non-accruals in fourth quarter to date?

James Briggs

Nothing to date.

Christopher Nolan

And then finally on -- looking through the deck and looking at the LTVs, which are roughly 75%, 80% or so, what sort of rent haircut are you applying when you evaluate those LTVs?

James Flynn

I don't think it's -- I mean, when we are looking at the assets, each one is an individual evaluation, meaning, basically it's going to be a view of what are the in-place rents. Most markets today have either somewhere in plus maybe two or three at the max to minus the same level, but some markets and some markets are slightly different. But in general, we'd be looking at in-place rents, particularly if they're a lot of these assets are still renovating and it'll still moving through their business plans, albeit higher to whatever changes market conditions have wanted. And so there's real-time data on what does it look like for renting new units today, but we're certainly --.

Christopher Nolan

So you're using this stated rent, right?

Zachary Halpern

We're often getting rent rolls, right? So this is real information. I think that, perhaps it's helpful to make a distinction between evaluating something like a CMBS bond in which you're looking at a tape of data provided to you by the server servers. Looking at multifamily loans, the way we're looking at it, which is asset management data, rent rolls, information that's coming directly from the borrower that's not necessarily been passed through data teach, et cetera. So it's a lot more foods on the ground and then you might see versus looking at CMBS bonds (inaudible).

Christopher Nolan

[Well, here's an issue]-- (multiple speakers), and then -- just FYI, I used to run a portfolio of four rent-stabilized apartment buildings in New York City was 218, rent-stabilized units. And when you talk to bankers in this space, at least in New York City, they give a haircut to their reported revenue of 20% -- 25%. Simply because what your reported rent is could be different to what the actual rent is. Like you get one month free or something like that. And if you're using what the stated rent roll is, doesn't that sort of overly inflate the value of the property on LTV basis?

James Flynn

So let me just address that specifically. So when we look at rents, we are taking into account the leases, the concessions. We're not saying someone's giving two months free and then charging, we're using what the real rent is. So concessions and things like that or not. But just also for context, we've seen or will see by the end of this month, every asset in our portfolio within the last since June or July summer. So over four months, we've gone out and visited every asset with someone from our team and visiting with the sponsor.
So to Zac's point, just these are transitional assets that had a business plan. They're not stabilized assets where a servicer pay someone to go out every two years to look at the asset. We are in contact with our sponsors on a regular basis, weekly, monthly, quarterly, whatever is appropriate for the given asset and are physically out there seeing them.
So there's a little bit more engagement there and real-time access to financial information than receiving a -- to the point of visits of large portfolio where you're receiving information secondhand and you're making some assumptions. We don't have to make those assumptions because we have the real data. There's (multiple speakers) know what it is.

Zachary Halpern

Yeah, I would layer on top of that. So a couple of things, one is the LTVs that are reported on the earnings supplemental or LTVs at time of origination, which is denoted there. But the underwriting that is done evaluating these assets is layering on all that nuance and not simply taking what the bar gives us as our underwriting.
Any nuance whether it be free rent for a month or two or negotiations on stabilization or issues on occupancy, that's all put into our underwriting and analysis as we're evaluating these loans both at underwriting and an ongoing basis.

Christopher Nolan

Okay. Thank you.

Operator

Ladies and gentlemen, with that, we'll close today's question-and-answer session as well as today's presentation. We thank everyone for joining today's conference call. You may now disconnect your lines.