Q4 2023 Brightspire Capital Inc Earnings Call

Participants

David Palame; Chief Compliance Officer; Brightspire Capital Inc

Michael Mazzei; CEO & Board Member; Brightspire Capital Inc

Andy Witt; President & COO; Brightspire Capital Inc

Frank Saracino; Member of the Board of Directors; Brightspire Capital Inc

Sarah Barcomb; Analyst; BTIG

Stephen Laws; Analyst; Raymond James

Matthew Erdner; Analyst; JonesTrading

Presentation

Operator

Greetings, and welcome to the conference BrightSpire Capital fourth-quarter 2023 earnings call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce to you David Palamé, General Counsel. Thank you, David. You may begin.

David Palame

Good morning, and welcome to BrightSpire Capital's fourth quarter and full-year 2023 earnings conference call. We will refer to BrightSpire Capital as BrightSpire, BRSP, or the company throughout this call.
Speaking on the call today are the Company's Chief Executive Officer, Michael Mazzei; President and Chief Operating Officer, Andy Witt; Chief Financial Officer, Frank Saracino.
Before I hand the call over, please note that on this call, certain information presented contains forward-looking statements. These statements, which are based on management's current expectations are subject to risks, uncertainties and assumptions. Potential risks and uncertainties could cause the company's business and financial results to differ materially. For a discussion of risks that could affect results, please see the Risk Factors section of our most recent 10-K and other risk factors and forward-looking statements in the company's current and periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, February 21, 2024, and the company does not intend and undertakes no duty to update for future events or circumstances.
In addition, certain financial information presented on this call represents non-GAAP financial measures. The company's earnings release and supplemental presentation, which was released this morning and is available on the company's website presents reconciliations to the appropriate GAAP measures and an explanation of why the Company believes such non-GAAP financial measures are useful to investors. Finally, during this call, management may refer to distributable earnings as the key.
With that, I would now like to turn the call over to Mike.

Michael Mazzei

Thank you. Welcome to our fourth quarter and full year 2023 earnings call and thank you for joining us this morning. I'll start by giving a brief update on the fourth quarter and what we anticipate for this year and then I will turn the call over to Andy for more specifics on the portfolio.
Let's first turn to Broadspire's results. For the fourth quarter, we reported GAAP net loss of $16.3 million or $0.13 per share fee of $25.4 million, or $0.2 per share and adjusted EBITDA of $35.9 million or $0.28 per share. Our dividend coverage for the fourth quarter was 1.4 times.
Now let's briefly discuss the financial markets. While the Fed has been back peddling on the timing of rate cuts, it is now clear that the higher for longer policy has come to a close. This pivot has caused a significant risk on credit spreads long duration bonds and big cap, even office suites have come off their lows from several months ago. The 10-year treasury yield initially dropped over 100 basis points and is currently about 75 basis points lower versus the October earnings call. In the commercial real estate debt markets, CMBS triple-A have tightened by roughly 50 basis points, and we saw very strong investor demand for the first CRE CLO print of 2024, which was also an actively managed structure.
The CLO cost of funds has tightened roughly 75 basis points over the past four months. Furthermore, most of online lenders have expressed interest in increasing their warehouse balance sheets for new loans and for good reason as through the cycle, these banks have seen their best credit performance in this segment of their lending portfolio for commercial real estate owners. These are clear signals that help us on the way during the second half of this year, we expect the beginnings of a meaningful reduction in the pricing of interest rate caps. And while lower rates alone will not solve all market issues, it will go a long way of reducing credit stress across all asset classes.
Turning back to BlackSpider, 2023 was challenging, but we continued to protect the balance sheet, maintained higher levels of liquidity and now have one of the lowest leverage ratios in the peer group. Maintaining these liquidity levels, coupled with our small average loan size of approximately $34 million, has helped us navigate the last 18 months. As we have stated in the past, it is problematic for liquidity when large loan concentrations constitute multiples of shareholder equity. On that note, Gary will provide an update on our two largest loans, the ultimate resolutions of which further reduce our own concentrations.
Looking ahead, with rates expected to decrease in the second half of this year, we're all looking forward to the positive bias this will have on credit quality. Alternatively, our entire sector has experienced earnings increases from the 500 basis points in rate hikes and now with the coming rate reduction of the Fed funds rate. This positive trend will begin to reverse in the latter portion of 2024. In addition, over the last 18 months the sector, along with Broadspire has recognized write-downs in capital.
Further, we experienced capital inefficiencies due to a combination of maintaining higher cash balances, lower leverage from both loan payoffs and warehouse line paydowns as well as an increase in unencumbered assets. These factors will be headwinds for earnings later this year. Therefore, the sector's 2023 dividend coverage levels should not be used as a guide for future earnings. These coverages should now for most as the year progresses.
Now looking forward, there will be about we'll be optimizing your existing capital base to offset these factors accordingly, in 2024, we will need to reverse the balance sheet trends of the past two years. As I previously stated, overall leverage stands at 1.8 times and our unrestricted cash is approximately $203 million. We also have low or non-earning capital in REO and some other assets during 2024. We will work to monetize and redeploy this capital more effectively. Importantly, the resolution of watchlist assets and providing more certainty on our loan book should also help close the gap between our market price and book value.
As we execute our plan to further stabilize the balance sheet, we will also begin to assess new lending opportunities. The actual deployment of capital will most likely be a second half of the year. Objective lending opportunities should further open up in 2024, along with the Fed easing rates, the regional banks will be seeking to reduce their CRE exposures. Keep in mind that regional banks hold about 70% of the commercial mortgages in the bank system. So as loans mature, especially construction loans, these banks will be far less incentivized to refinance these loans on their balance sheets. In addition, more regional banks will be included under the new Basel three rules. These factors will become tailwinds for nonbank lenders.
In closing, we are becoming more positive about the opportunity set in the not-too-distant future. We will look to play offense for the first time in almost two years and with that, I will now turn the call over to our President, Andy Wade.

Andy Witt

Thank you, Mike. Good morning and thank you all for joining throughout the fourth quarter. Much like the rest of 2023. Our focus was on asset and portfolio management. During the fourth quarter, we received $132 million in repayments across four investments, which included a partial repayment of $57 million for the San Jose hotel loan. As a result of sales, proceeds from the South Tower loan has been paid down to $136 million. The remaining collateral consist of the original 540 room hotel, including all back of house infrastructure amenities and conference space. The hotel is currently being marketed for sale by the borrower. In addition, during the quarter, we received repayments on two office phones and a multifamily loan. Subsequent to quarter end, we received an additional $27 million in loan repayments.
Looking ahead, we received a repayment notification from the borrower of our largest office loan and expect to be paid off in March. The loan has a current balance of $87 million and a future funding obligation of an additional $13 million. We also anticipate several more loan payoffs or paydowns in the office segment of our portfolio in the coming months, further reducing our exposure to this asset class.
Additionally, the sponsor on the South Pasadena, California office loan recently completed have zoning entitlements on land surrounding the existing and fully occupied office buildings. This upselling is for residential senior living and it far exceeded expectations, substantially increasing the value of our collateral. While we still maintain this asset in the office segment of our portfolio at year end. We intend to recharacterize the loan next quarter given the value creation and transformation of the underlying collateral.
Lastly, as it relates to office exposure within the portfolio for Washington, D.C. office property, which we took ownership of during the fourth quarter, is currently being marketed for sale. We should have more definitive information to share by next conference call.
The multifamily portion of our portfolio has largely remained resilient. In the face of a difficult macro backdrop, we are seeing a slowdown in top line growth after years of outsized rental rate increases. We expect top line growth in this sector to remain relatively flat over the next 12 to 18 months as new supply is absorbed certain policies adopted during COVID have been detrimental to the sector. However, as those policies wind down, operators are making progress on their value add business plans, we have been working very closely with borrowers on loan extensions and rate cap requirements.
Looking ahead, we continue to believe the fundamentals for housing remains strong and once the product currently under construction is absorbed, there is very little in the pipeline behind it, which bodes well for the sector.
Turning to our watch list update, the list remains relatively consistent with last quarter. First off two risk ranked five loans were removed from the list. As previously mentioned, we took ownership of the property underlying the Washington, D.C. office loan. Additionally, we also took ownership of the property underlying it previously risk ranked five Phoenix, Arizona multifamily loan. As we discussed last quarter, the borrower was unable to secure the incremental funds needed to execute the remainder of the business plan. We are in the process of executing a value-enhancing business plan, which we expect will take several quarters to implement after which time we anticipate taking the property to market. We were able to retain our financing on this Phoenix multifamily property.
We had only one watch list loan downgrades during the quarter, a Denver, Colorado multifamily loan, which was placed on nonaccrual and downgraded from a risk ranking of four to five. The borrower is currently marketing the property for sale as of December 31st, 2023, excluding cash and net assets on the balance sheet. The portfolio is comprised of 87 investments with an aggregate carrying value of $2.9 billion and a net carrying value of $855 million or 78% of the total investment portfolio. Our weighted average risk rating remained flat quarter over quarter at 3.2.
The average loan size is $34 million and the loan portfolio has minimal future funding obligations, which stand at $168 million or 5% of outstanding commitments. First, mortgage loans constitute 97% of our loan portfolio, of which 100% are floating rate and all of which have interest rate caps for the multi-family portion of our portfolio remains the largest segment with 51 loans representing 53% of the loan portfolio or $1.5 billion of aggregate carrying value office comprises 33% of the loan portfolio consisting of $960 million of aggregate carrying value across 27 loans with an average loan balance of $36 million. The remainder of the portfolio is comprised of 7% hospitality with Industrial and Mixed Use collateral making up the remainder.
With that, I will turn the call over to Frank Saracino, our Chief Financial Officer, to elaborate on the fourth quarter results. Frank?

Frank Saracino

Thank you, Andy, and good morning, everyone. Before discussing our fourth quarter and full year results, I want to mention that our fourth quarter 2023 supplemental financial report is available on the Investor Relations section of our website.
As Mike mentioned, for the fourth quarter, we generated adjusted EBIT of $35.9 million or $0.28 per share, flat to the third quarter. Fourth quarter DSO was $45.4 million, or $0.2 per share. Fee includes a specific reserve on one multifamily loan of approximately $10 million, where we also took ownership of the underlying property during the quarter. Additionally, we reported total company GAAP net loss of $16.3 million or $0.13 per share, which reflects the sequential increase in our CECL reserves, small impairment taken on one REO asset for the full year of 2023, we generated adjusted EBITDA of $138.2 million or $1.6 per share, representing a return on undepreciated shareholders' average equity of approximately 9.2% our dividend for the year of $0.8 was well covered at 1.33 times quarter-over-quarter. Total company GAAP net book value decreased to $9.83 from $10.11 per share. Undepreciated book value also decreased to 1135 from 1155 per share. The change is mainly driven by an increase in our seasonal reserves and partially offset by adjusted DY. in excess of dividends declared.
Looking at reserves, our specific CECL reserve decreased from $35 million to zero. The decrease was driven by the charge-offs related to our taking ownership of the properties underlying the Washington, D.C. office load and Phoenix, Arizona multifamily loans, no specific reserve was required on the Denver, Colorado multifamily loan that was downgraded to a fund. Our general CECL provision stands at $76 million or 246 basis points of total loan commitments, an increase of $21 million from the prior quarter. The increase in the general seasonal was primarily driven by economic conditions as well as specific inputs on certain hotel and multifamily properties.
Looking at watchlist loans. Our one rich ranked five loan represents 1% of the total loan portfolio carrying value. Nine loans equating to 15% of the total loan portfolio carry value are risk ranked four. While all restraint for loans are current performing loans, we see potential for increased risk and accordingly are monitoring these investments and working with sponsors to ensure the best outcome.
Moving to our balance sheet, our total at share undepreciated assets stood at approximately $4.4 billion as of December 31st, 2023, a slight decrease from the last quarter, our debt to assets ratio is 62% and our debt to equity ratio is 1.8 times, a slight decrease quarter-over-quarter. We have no corporate debt or final facility maturities due until the second quarter of 2026. In addition, our liquidity as of today stands at approximately $368 million. This comprises $203 million of current cash and Mike referenced earlier, as well as $105 million under our credit facility.
This concludes our prepared remarks. And with that, let's open it up for questions.
Operator?

Question and Answer Session

Operator

(Operator Instructions) Sarah Barcomb, BTIG.

Sarah Barcomb

Hey, everyone. Thanks for taking the question. I just wanted to dig into the multi-family portfolios here on those additional downgrades related to sponsors on not willing or unable to buy new interest rate caps for the most part. And can you provide any commentary on your overall exposure to syndicated sponsors that might have bought these properties during that low interest rate period?

Michael Mazzei

Cop magazine. I'll start off with that. I think Andy can add some color there as well from here. So the downgrades were there are some similarities in that.
Yes, I think that's indicator exists across many portfolios on there are issues with execution on those specific properties. Some of them are related, as Andy said in his stated remarks of the COVID related policies that are inhibited owners from a from a moving tenants out of the assets. So there were value add issues in terms of the business plans in terms of executing on value add. So we had some of those issues with regard to the the property that went REO. As Andy said, it could take us a couple of quarters, several quarters to move out of that. So yes, we had some issues with the syndicator. We are closely monitoring that we've had. Our exposure is limited. It's been a handful of assets that we've had one of the assets on the watch list is being supported by the preferred equity behind the asset, but we continue to have it on on the watch list as well.
In terms of interest rate caps across the portfolio of multifamily borrowers are buying caps. They are seeing visibility in terms of ultimately getting across the bridge, as Andy said, through the supply end and getting on with their programs. So bar was generally in multifamily have been sticking with sticking with the assets and buying caps and anything you'd like to add to that.

Andy Witt

I think, Mike, you covered it. The one asset that went from the risk rate five to REO is currently in the process of going through renovations and lease up and that's a process that we expect to transpire over the next couple, three quarters after which time we expect to take that asset to market on a more stabilized basis.

Sarah Barcomb

Okay, great. And yes, we've seen some of these multi-family on noise across the space this quarter, and that's to be expected just given where so for on is these days, but just shifting over to Office on. It seems like there's some positive telegraphed here for the office portfolio. I'm expecting some repairs in the future here on there was one downgrade, but it wasn't watch listed basically my question is at this stage, do you feel that the office credit arm is pretty well ring-fenced at this point?

Michael Mazzei

I wouldn't go as far as to say, that, honestly, I don't think anybody can given the work-from-home issues that are out there. The issue with office is going to be getting taken out of those assets with refinancing and so I think right now that has proven to be very difficult and you're seeing that being reflected in some of the severities on loans have been taken back. So generally on office I'd say is, as Andy said, we we are in the process of selling the Washington, D.C. asset. I think we have some encouragement down the number of bids.
We got and we're working through reviewing those bids now and we'll have something more to say on that generally in the office portfolio, the Q4 it was Sara stable. We didn't see anything that was slipping materially. We have had some successes. As Andy said, the largest asset that we have has indicated that they're paying off the loan of the South Pasadena asset with the upsizing and zoning was so substantial that we actually may. We characterize alone from the Baltimore asset, which we've talked about in previous quarters, is now 90% leased with what will be when the tenant takes occupancy, a very high debt yield in San Francisco. We have two assets that are smaller, both are fully occupied with new leases.
We get a special deal on LA for a single tenant that is now going to be fully occupied. And as Andy also mentioned, is that there are assets on the horizon that we think are going to pay off most notably an asset, an office asset in Florida. So we've seen some good a good positive movement there. But for the rest of the portfolio, it's about visibility for borrowers. And unlike what I just said about multifamily will borrowers see housing shortage and over the horizon, they could they say these are assets that we know will ultimately perform. So they're sticking with them generally.
And we're seeing a lot of liquidity in that market. The asset, the REO asset that we are working with the borrower who's used marketing the asset for sale on that. And I think they're seeing a lot of interest in that asset. There's not much more I can say, but there's a lot of interest and a lot of liquidity on the multifamily side, the office assets, those are the assets we'll be watching more closely in terms of confidence around deploying capital. So while we've had some market improvement this quarter in terms of what will be a reduction in the portfolio. But I still think going forward, that's the area that we'll be watching more closely because those borrowers have the least liquidity in terms of refinancing, but otherwise, the quarter was for the balance of the portfolio. The quarter was absolutely stable.
Anything else queue?

Operator

(Operator Instructions) Stephen Laws, Raymond James.

Stephen Laws

Morning, Mike, I guess to start you, it seems like you're incrementally positive as you look out later into this year. What prevents you from going on offense sooner given the very low leverage and liquidity position. Do you want to see the expected repays on office get across the finish line? Is it something else that you want to see macro maybe rates start to rollover and get better visibility, kind of what we given the kind of seems like improving tone kind of widening, feel of the need to wait another four to six months to kind of go back on offense?

Michael Mazzei

Well, first of all, I don't think we're missing anything in the next four months. I think the transaction levels are still low because borrowers cannot get the proceeds out for their existing assets and transactions have been a lot slower because of rates in terms of us and why we're waiting. First of all we have to get more confidence around them, the stability of the portfolio, as I said in the prepared remarks, we want to see more stabilization now because the first constituent that we look at as all banks, we want to make sure the banks are protected and we have the cash to do so. No banks, no, no mortgage rates. And let's just be direct about that. So our banks are priority number one in terms of new investments. And when we look at it, a lot of there's been a lot of talk about buybacks. We've repeatedly said that we don't see buybacks as really moving the needle. They're small. They don't do much in terms of moving the stock price. We don't want to shrink our capital base. And so really, we're looking at new investments over buybacks.
And when we do the new investments is really about the confidence and how we would spend we spend our cash and for the second half of the year, if we if we can, if we could get some of the things we talked about accomplished in the first half, improving the watch list, getting some movement movement on the REO, then I think we'll have the confidence to start spending cash, and that's really more of a second half of the year thing and maybe we can look to deploying something like $50 million to $75 million of cash in the second half, if we can get some really good good visibility on the balance sheet in the first half of the year. As we mentioned, we have we do have and you mentioned we have $100 million of REO that is undrawn or totally not levered on. Hopefully we'll get some tailwind on the Long Island City REO. We do have some a lot of interest coming on that asset, particularly one specific user that may have interest in and the Paragon asset and overflow into the into the Blanchard assets. So right now, really looking to stabilize the portfolio further and get the confidence in the second half of the year. And I think by the way, if we can get if we can deliver more certainty around the asset performance and we were all talking about stock price. I think the largest thing embedded in our 60% of where we're trading 60% of book value is uncertainty. So really we're moving some of that up that said the BISx blessed portfolio and executing on the watch list and moving some of the REO that we think is going to be the bigger impact on the stock price and getting it up over 60% of book.
But I'll also add in terms of opportunities, as I said on the call, I mean, there are thousands of regional banks out there smaller banks that we weren't even looking at that were originating loans and participating in commercial real estate lending. And virtually every bank that comes out on their earnings call has to lead off with our real estate exposure is only X and we don't have exposure to New York City multi. And so we're seeing that coupled with Basel three, we're going to see the banks not originate as much maybe pull back. And as I said on the call on construction loans as they come due, they would normally refi those into many firms and then those loans would find permanent financing later. We think the evolution of those floors are going to be from construction. I'm going to come off that balance sheet and the non banks and debt funds will have an opportunity to do what I've been there, many times that the banks would have done. So we think that the some of the the well from the banks to originate loans has diminished greatly and they're all going to have a bias towards shrinking their portfolios. And there are so many of them out there that we weren't even looking at that.
We didn't need hereof Noel's.
I think all of that is going to be coming at us in 2024. So I think there will be ample opportunity for the banks to want to have products.

Stephen Laws

Appreciate the color. There would be certainly interesting to watch the retrenchment of those those banks and opportunities that provides you have. Can you touch a little bit more on that at the property level on multifamily? And I've heard a couple of others mentioned on some underperforming or nonperforming tenants that have been stuck in assets due to some COVID policy issue. When did that start to change? And how was it easier now to get those tenants out and replaced with new tenants kind of can you talk about that process and what you're seeing kind of re-tenanting some of these multifamily assets and a little over a year of?

Michael Mazzei

Okay. Sure.
Thank you, Mike. So I think we have seen an easing of some of the COVID policies. Those have oftentimes been regional in nature. So they rolled off over different periods of time. But generally what occurred was the inability to access units and start the renovation process and execute on the business plan, the value-add business plan. And so it affected the borrowers' cash flows and so forth. But what we're seeing now is borrowers are able to get to the assets that we have, take them through renovation and and get them stabilized. So it was a period where oftentimes the borrower just wasn't able to execute their business plan and it was at great expense to them. Now we're seeing less of those impediments and we have the opportunity to go ahead and execute on that plan.

Operator

(Operator Instructions) Matthew Erdner, JonesTrading.

Matthew Erdner

Your Morning, guys. Thanks for taking the questions. Are kind of following up on the prior one and you know, as loans kind of payoff and some REO gets sold, is there a minimum or I guess maximum amount of cash that you guys want to defend the portfolio before you start turning to offense and deploy some additional cash into new loans?

Michael Mazzei

Well, I think that we've had a policy in the past. I know that we've had a policy in the past, we want to maintain minimum cash. We really we have a revolver and we really have never tapped the revolver and we don't look to do the math. So I think in terms of minimum cash would be probably something like circa $100 million bucks in this market. I think previously before the Fed's hikes, we were looking at more like $75 million. So I think we want to have a little bit more cash because of the uncertainties I outlined I outlined earlier. And as I said, there's a lot that we can tap into. Certainly the REO, our large, our largest asset is also probably the least levered asset on our warehouse lines right now. So if that asset resolves itself, which we expect then we should free up capital there that we can relever. And overall, our leverage at 1.8 times is among the lowest in the peer group some folks I have hovering around mid to some folks are hovering in the fours where at 1.8. So we have to figure out a way to lever up the portfolio. Some of that will be by just doing new loans and putting 75 80% leverage leverage against those. So right now, $200 million of cash and hopefully we'll harvest some of this REO over the next several quarters and be able to redeploy that get a solution on our largest loan, which is very underlevered. And I think minimum he's probably something about 100, maintaining about $100 million cash on the balance sheet balance sheet, at least through the early part of 2025.

Matthew Erdner

Yes, that's helpful there. And then in terms of new loans, are you guys kind of scouting out or looking at some deals in the marketplace, even though you might not take them until second half and if so, what's kind of the asset type and geographic region that you guys want to target when you do go back on offense?

Michael Mazzei

Yes, I would say that the Periscope is up and we are looking absolutely we've been attending all the conferences. Our originators have stayed in contact with their constituents are actively involved in getting color on the market today. I think much like some of the other guys in the peer group have stated we are focused on multifamily hotel until and not really office. It would have to be a very very unique opportunity for us to be involved in and putting on an office asset. And we redid our bank lenders would have to be such an opportunity that our bank lenders would have to agree with us and they want to finance that on the CLO market. We've seen all multifamily come through to date, and that's a great vehicle for that for financing now guide us to doing that and doing more multi-family as well. I think that the opportunity is going to be construction of the banks, as I said normally did the many firms. I think the banks are going to be running away from that.
In terms of region, everyone talks about the oversupply in the Southeast and Southwest, but I would still say that there are certain states that are doing the best that they possibly can to chase residents out of the state. And we think that's going to actually continue. And so as long as that continues and we're seeing quality of life issues and budget. So boring in some of these states, we think and taxes potentially going up while there is supply that is in the Southeast, everyone is talking about. We think over the horizon, as Andy said in his prepared remarks, you get out 18 months pipelines really dissipate. So we think those regions of the of the U.S. are still the best regions to lend. And not to say that there will be pockets that you'll do in other areas. But from a macro perspective, the south side is better than the north side.

Operator

I would like to turn the call over to Mike Maffei for closing comments.

Michael Mazzei

We'll brag you all for joining us today and we look forward to speaking again in May. We will hope to make some progress on the items that we outlined. Thank you all for joining.

Operator

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.