Franklin BSP Realty Trust, Inc. (FBRT) Q4 2021 Earnings Report, Transcript and Summary

Good morning, and welcome to the Franklin BSP Realty Trust Fourth Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe, Vice President of Investor Relations. Please go ahead.

Good morning. Thank you Andrew for hosting our call today. Welcome to the Franklin BSP Realty Trust fourth quarter earnings conference call. As the operator mentioned, I am Lindsey Crabbe, VP of Investor Relations. With me on the call today are Richard Byrne, Chairman and CEO of FBRT; Jerry Baglien, Chief Financial Officer and Chief Operating Officer; Mike Comparato, Head of Commercial Real Estate; and Roy Kim, Managing Director of our Capital Markets Group. Before we start today's conversation, I want to mention that some of today's comments from the team could be considered 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 Form 10-Q filed with the SEC and actual future results may differ materially. The information conveyed on this call is current only as the date of this call, February 24, 2022. The company assumed 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, 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'll turn the call over to Richard Byrne.

Great. Thanks, Lindsey. Good morning everyone and thanks for joining us. I'm Rich Byrne. I'm the Chairman and CEO of Franklin Benefits – Franklin BSP Realty Trust, or as we call it FBRT. There is clearly a lot going on in the markets right now. So we appreciate all of you making time for our call today. As Lindsey mentioned, our earnings release and supplemental deck are published on our website and they're available now. They were published yesterday evening. For this call, we're going to review fourth quarter results and highlights and walk you through the current status of our portfolio. We will also update you on what has occurred since the end of the year, specifically on our residential ARMs portfolio. After that we're going to open up the call for your questions. The supplemental deck also provides more information than can cover today, but hopefully you'll find it useful to look at that information in addition to what we go through. You'll note that our Q4 2021 is the first time, this is the first quarter we're able to show fully consolidated financials following the closing of our merger with Capstead, remember that occurred mid-quarter on October 19, 2021. As a reminder, prior to our merger, we were a commercial mortgage REIT operating as a non-public non-listed REIT since 2016. The opportunity to merge with Capstead represented a strategic transaction for our future growth prospects. It gave the predecessor REIT immediate scale and additional liquidity and it represented an opportunity for the Capstead shareholders to transition out of the lower ROE business into a historically higher ROE business. Jerry will cover the financial highlights in a few minutes and Mike will discuss the portfolio. But before that I will provide some greater market color and I wanted to go through FBRT's current position and the progress we've made in our first few months of being a publicly traded. I'll start all that on Slide 4. Looking at our commercial real estate platform, Q4 was indeed a record breaking quarter that led to a record breaking year for FBRT. Our origination business was strong in the fourth quarter and it was also very strong throughout the entirety of 2021. We brought our CRE portfolio or our core portfolio to $4.2 billion of loans at year end. This is up approximately $1 billion from Q3 and $1.5 billion from where it was at the beginning of the year. Our ability to achieve such strong origination numbers was due to our ability to make significant progress selling the residential ARMs book we acquired through the merger. To give a bit more context on that, the merger closed on October 19th, as I mentioned. From that period through year-end, the ARMs portfolio decreased by approximately $2.3 billion from both strategic sales and runoff. The ARMs portfolio at year end was $4.6 billion. This compares to $7.1 billion at 9/30. The truth is we exceeded our own expectations on the pace of this disposition. It was a great time also to test our ability to redeploy the assets, which we clearly did. We originated $1.6 billion of new commitments in Q4, which is roughly 3x our normal origination volume. That has continued in Q1 as evidenced by our strong pipeline. Something many of you will be interested to know is our progress on the ARMs sales in the first quarter as well. Our progress has been great. The ARMs portfolio has been further reduced by another $2.2 billion. Now our total ARMs portfolio stands at $2.4 billion. That's a 66% decrease versus last quarter. Jerry will go through this in more detail and I'd also mention that we've been very pleased with our execution selling these bonds at very close to their marks. Let me just take another second to put that into context. On 9/30, as I mentioned before, the ARMs portfolio that we inherited was $7.1 billion in size and our core portfolio is just a little bit over $3 billion. Today, our ARMs portfolio, as I mentioned, is $2.4 billion and our core portfolio, or our commercial portfolio, is $4.2 billion. In other words, we've completely turned upside down the ratio of what this company consists of. And our objective is to continue the rapid pace of transition from residential ARMs to commercial loans, given the higher earnings potential and lower historical volatility and also the lower leverage of our commercial or core portfolio. I would also like to provide an update on the company and manager buyback programs. We continue to have the full $100 million buyback available to us. This includes the first $35 million from BSP and Franklin Templeton followed by $65 million from the company. Since December 15, we have been blacked out from trading due to legal restrictions, so we have not been permitted to use any of our dedicated buyback proceeds during the market volatility since then. With yesterday's release of earnings, those restrictions will be lifted starting this Monday. Given the significant discount in our stock, especially it is price to book value, it is our intention and the company's intention to support the FBRT's shares. This can be accomplished through open market purchases as well as a 10b5-1 plan that will permit us and the company to continue to buy when the company's trading window is closed. Before I turn it over to Jerry, I just want to say a few words about 2021, because it really was a historic year for the company. When BSP took over the REIT in 2016, we had two primary goals. First, we wanted to stabilize the business and turn it into a best-in-class middle market commercial mortgage REIT. Second, we wanted to provide our shareholders with a liquidity event. As we look back on the five year period, we're very proud of what we accomplished. Clearly, we've achieved both goals. In the five year period, we have increased the company's revenues by approximately 190%. We've increased our core book of originations from basically zero to $4.2 billion today, or at year end, and increased distributable earnings by approximately 350%. In our five years of running this business, we have never had a credit loss on a BSP originated loan. We have built in our opinion one of the top middle market commercial real estate origination platforms in the business and we're very proud of that. And of course in 2021, we delivered a liquidity event through this merger. As we continue to transition Capstead's asset base into our CRE portfolio, we are extremely excited about the opportunity in front of us. With that let me now turn it over to Jerry to go over our financial highlights for the quarter. Jerry?

Great. Thanks, Rich. Appreciate that. Hello everyone. I'm Jerry Baglien. I'm the Chief Financial Officer and Chief Operating Officer of FBRT. I appreciate everyone calling in today. Moving on to the results, let's start on Slide 5 if you're following along. The first thing I want to start with in Q4 FBRT generated distributable earnings of $34.6 million, or $0.36 of share, and that's on a fully converted share basis, so assuming all the conversion of the preferred that we have. That represents an 8.2% distributable ROE. A full walkthrough of how we get to distributable earnings to GAAP that can be found in the earnings release in the details. In terms of the distributable earnings number, it includes $107.5 million of adjustments, and that's driven primarily by the $88 million relating to the merger. Specifically, there is $40 million adjustment embedded in that. And that represents a change in value between the end of the quarter 9/30 to 10/19, a change in fair market value from the date we kind of struck the merger, today we actually took over, so a significant component of that is mark to market. Another important thing to note is that on our core portfolio, our quarterly distributable ROE was 10.2%. And if you look at that on a full year basis, it's 11.9%. In terms of dividends, we paid an aggregate common stock amount of 35.5 cents per share for the quarter that represents a yield of 8.2% on our fully converted book value of $17.25 a share. Our leverage was at 4.1 times on a net basis at the end of the quarter and our non-recourse leverage ended the quarter at 2.9x. As we continue to transition out of the ARMs securities, we expect our net leverage to continue to decrease coming back into a more normalized range for us somewhere around 2.5x. If we move on to Slide 7, you can see that we closed $1.6 billion of loan commitments in the quarter. On a net portfolio growth basis, that's $970 million of additional growth in our core portfolio and takes us up to $4.2 billion over 165 different positions. Moving on to Slide 8, you can see that in December we issued $900 million CLO. That was our seventh CLO in our largest to date. It continues our focus on non-recourse non-mark to market funding from our core book. Following that we announced last week that we surpassed that record in Q1 with a new CLO that was $1.2 billion in size. This was another transaction that was very well received by the market and included both new and existing investors. Another point I want to mention on the liabilities in conjunction with the merger and the growth of our size, we upsized the balance of a number of our warehouse facilities and we now have agreements with five separate counterparties. Moving on to Slide 10, we can dive a bit into the ARM portfolio. At the end of the year, the fair market value of the ARM portfolio stood at $4.6 billion compared to the $7.1 billion at 9/30. So we made excellent progress in terms of our liquidation. If we go on to Slide 11, I can give a little bit of an update on in terms of where we're at for the first quarter. So we've continued to make progress on redirecting the residential ARM book through sales and pay downs. We sold an additional $1.8 billion in January and February so far. And through February 18, the current fair market value of the residential ARM portfolio was $2.4 billion, which is roughly a 66% decline from the date of the acquisition. The reduction of the value to ARM Agency Securities portfolio is due to two things, primarily two things: $265 million of principal payments on the portfolio and another $1.8 billion of sales. In the first quarter, in terms of change in value, we've experienced losses of roughly $38.1 million relating to the ARM portfolio. This is driven by changes in value in addition to pay down, sales and hedging, so a total net number across all those items. With that, I'll turn it over to Mike to give you an update of what we saw in the market during fourth quarter.

Thanks, Jerry. Good morning everyone. I'm Mike Comparato, Head of Commercial Real Estate. Appreciate your being on the call today and I want to reiterate that our thoughts and prayers are with the Ukrainian people. I'm going to start on Slide 12. Q4 was a record quarter of originations for our team. We were easily able to put the capital generated from the Capstead residential ARM sales to work in new originations this quarter. We originated 38 loans during the quarter and are looking at a robust pipeline today that is in excess of $1 billion in size. Generally, we expect to have a similar pace of originations in 2022 as we did in 2021. Multifamily continued to be our largest add this quarter with over 93% of originations in the multifamily sector. Going to Slide 13, it shows our exposure to multifamily at year-end is up to 70% of our core loan portfolio. We continue to find multifamily an attractive sector to invest with strong loan demand and excellent credit performance in our portfolio. That being said, we remain concerned with the complacency in the multifamily markets. The lack of cap rate tiering between major markets, secondary markets and even tertiary markets continues to be caused for concern. The lack of cap rate tiering for materially different vintages within the same market is also cause for concern. We do not believe this to be a healthy market dynamic and more so not a healthy dynamic in what we believe to be a rising interest rate environment. Accordingly, if you look at our multifamily originations over the last several quarters, you'll notice that our focus has been on higher quality, newer vintage assets and strong primary markets. We believe in a multifamily valuation pullback, higher quality, newer vintage assets and primary markets will be less volatile, have stronger value retention and be more liquid. While our focus for most of 2021 was in multifamily lending, the DNA of our company remains very much the same as it has always been. We are looking for value-add investments with appropriate credit and risk metrics. While higher quality newer vintage multifamily assets located in primary markets was a sector of choice in Q4, we are actively looking to increase exposure to non multifamily assets if we can achieve what we believe to be the correct risk adjusted returns. Our geographic footprint remains in line with where it was in Q3. We're still finding strong opportunities in the Southwest and Southeast regions while selectively investing in other markets. Our risk rating remains unchanged for the quarter with only one loan on non-accrual or watch list status. All in all it was an exceptional quarter and year for the commercial real estate portfolio and I believe the portfolio is stronger than it has ever been. I briefly want to provide an update on the team. We ended the year with 75 professionals and of that have 17 managing directors with deep relationships and decades of experience. Over 50% of the loans we originate are with repeat borrowers and/or brokers and we are well positioned to continue to grow this portfolio. Lastly and very importantly, to reiterate what Rich mentioned earlier, Q4 2021 represents the 21st consecutive quarter that we've been managing the REIT as we’ve not experienced a single credit loss on any loan originated by BSP. Of all of our achievements, certainly through a global pandemic, we believe this to be the most important. This no loss performance highlights a strong credit culture and a robust experienced internal asset management team. We're incredibly proud of that performance and the team. And with that, I would like to turn it back over to the operator to begin the Q&A session.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Steve DeLaney with JMP Securities. Please go ahead.

Hi, good morning everyone and I share the – sharing thoughts and prayers for Ukraine this morning. We all had to wake up to that news. While it's obviously a little hard to focus on our own real estate markets right now, I was wondering, Rich, if you had any kind of high level thoughts about how – what is going on in Europe, how it might impact our fed and any decision, the decision that we expected that they would make to raise interest rates.

Mike, do you want to start that off?

Sure. Hi, Steve. Thanks for the question. Look, I think, the fed has been remarkably open about their plans going forward, clearly battling inflation and clearly in a hawkish position. I think there has been a lot of debate of late between the 25 or 50 basis points coming in the March meeting. This probably gives them cover to only raise 25 pretty easily. I don't believe that this will change the long-term position of the fed overall. Obviously, we're in the very early hours of this whole development, so that remains to be subject to. But as it stands today, short of major further escalation, I would not expect them to change the long-term path.

That makes – that makes – yes, yes, Rich.

Go ahead.

I'm just going to say…

Please go.

Okay. So, lower – from your borrower's perspective I would think lower for longer would certainly be viewed as a positive in terms of their cost of borrowing. But from the way you manage your portfolio and you look at FBRT, it would appear that you should be somewhat agnostic regarding interest rates. Am I correct on that comparison between your borrowers and your own portfolio – job with your views?

This is Jerry. Maybe I'll start and let somebody else jump in. But to some extent, certainly, I mean, I think you've seen the floors that we had dominate the portfolio 6 to 12 months ago, a lot of that has gone down significantly, so the net benefit from those have kind of burned off. So I think we are much more agnostic now than we were a year ago, which is probably the norm that we're seeing across the space with everybody.

Yes. And I would just point out, Steve. I think that applies to the core portfolio. Obviously, our conduit business is much smaller than the overall core business, but higher rates we actually think would help our conduit business net-net for a few different reasons. But again, that's…

Interesting.

…a smaller piece of what we're doing overall.

Okay, go ahead.

And Steve, just in broader context…

Yes, go ahead.

I mean, we have shrunk our ARMs portfolio by $4.7 billion…

Right.

The 2.4 today as you heard a lot of those sales took place in Q4 sort of ahead of this recent downdraft. So, I think, the easiest most non-controversial prediction is volatility. And just given the higher leverage and more historical volatility of the agency securities, I mean, the good – one of the good things is on the ARM side duration is generally shorter, so you're not going to see maybe quite as much of all as you see in some of the more traditional agency guys. Also, I mean, I'll just add, you didn't asked, but we've deployed a – what we consider a more conservative hedging strategy. We're thinking about hedging as short term owners, not as hedging a portfolio over a long period of time trying to…

Understood.

…and other things. So we think on the combination of how aggressively we've hedged, the sales we've made, I mean, we sort of avoided a lot of what's occurred. I mean, if you think about it other than the March quarter of 2020, the COVID quarter, this has been sort of the worst period for – on the resi side certainly.

Sure.

And I don't know, probably as long as you've been covering it, Steve. So, we're pleased that we've made such progress on lowering the book and just given the volatility ahead, we're just excited where we actually think we have in many cases the opportunity to redeploy into potentially even wider spread commercial lending opportunities.

Okay and understood. And the short duration definitely helps. We've seen book value losses date going back to – with the last couple months of 2021, the first month or two this year of double digit, 10% to 12% for some highly levered residential mortgage REIT. So your portfolio has obviously benefited – held up much better. Jerry, just to close out with you. I think you mentioned that the fair value marks thus far in 1Q 2022 were $38 million on the ARM portfolio. Is that correct?

Yes, that's net of hedging, correct.

Right. Okay. So that with 90 million shares, that's going to be about $0.40 that we should expect to see…

Exactly.

…or decline in book value. Is – how will that flow through? I assume we'll see that in distributable earnings. And is there – would that item have any impact on your dividend payout here in the next quarter or two? How do you view the fair value loss?

Sure. First part, yes, I mean, that'll just come through as a trading loss, but we don't really consider that a run rate loss from – thinking about are distributable.

Okay, sure.

The cost of wind down more than a cost of operations, that's kind of how we interpret that. But in terms of earning power, I don't think we're uncomfortable with the level we've set it at. And if you think back to kind of what I said on what the core portfolio is earning, if you look at that just distributable amount that is higher than the dividend rate that we're paying on the totality of the company. So, a lot of this is predicated on the shift out of ARMs and into the core where we see much better returns clearly.

Okay. So just the cost – sort of a one-time item cost of winding down that portfolio, but other than that whatever the actual hit is to book value from a distributable earnings dividend standpoint going forward that sound like there'll be any material impact.

That's how we see it right now, correct.

And Steve, just to pile on there, you probably remember when we announced our merger, we had sort of said we were very comfortable with the 35.5 cents that we're paying, just to echo what Jerry said for the, at least, intermediate future as we manage through this transition. Obviously, we're earning or have historically been earning a higher ROE on our core book, but the blend between that and the ARMs, lower ROE arms portfolio, we feel comfortable continuing with that 35.5 cents as you saw we earned $0.36. So we're covering it, but that's the plan.

Thank you each for your question – your comments. I appreciate it.

The next question comes from Jason Stewart with Jones Trading. Please go ahead.

Hi, good morning. Thanks for taking the questions. I wanted to ask about the comments on the multifamily and the competition there and maybe you could give us some other maybe more specifics in terms of either geography or asset class that you think looks interesting. And maybe if you could just put a finer point on sort of where to expect margins going forward in multifamily if they continue to compress or sort of had that economic picture has changed from an origination standpoint.

Yes. Thanks, Jason. I think if you look at the – for better or worse, the core business or the floating rate business has become highly tethered to capital markets and CRE CLO execution. So I think you're going to see asset spreads very much trend and follow what we're seeing in the CRE CLO market. And clearly, those spreads along with all of the other spreads that we've been watching in the marketplace have been going wider. So I think if you look back to Q3 of last year, kind of the tightest pricing that we were seeing from a spread standpoint was probably in the high 200s, maybe 275. I think, before this morning's news, we were seeing that wider by 50 to 60 basis points. So, kind of hearing multifamily spreads are going to be in the 325, 350 range for your generic kind of 75% loan to cost multifamily Bridge Loan today.

Okay. And so, assuming that is following financing spreads in the CLO market, I'm guessing that doesn't change your decision or appetite to move into other asset classes where you can get better risk adjusted returns. Maybe you could just put a little bit more color on – is it office, is it a geographic area that's interesting. What sort of should we expect to – that portfolio to look like in terms of originations over 2Q, 3Q this year?

Yes, I think, we're pretty bullish on leisure oriented hospitality. We've been focusing on origination in that space. We're also selectively looking for some retail opportunities, not in closed malls, but open air centers in good demographic areas of the country. Office, we're still hesitant on from a macro standpoint. We believe the long-term ramifications of COVID and work from home have yet to work their way through the system. And we just are uncertain of the long-term demand for office space. So, we're not opposed to office, but that's probably where we have the highest credit bar today. And then I think you'll see some – also some esoteric investments from us as we've always done, whether it's condo inventory loans or multifamily construction loans, things of that nature that we're usually able to find very nice pricing.

Got it. Okay. That's helpful. Thank you. And then one more, just in terms of your thought process from origination to just this gestation period from origination to CLO execution, nice sharp [ph] pricing the last one, but $1.2 billion is a big CLO. How do you balance that time period with this volatility and spreads that is expected to continue the size of the CLO getting up the proper scale versus that time period of risk that you have to take. How do you think about those two?

Obviously something we're always thinking about and managing to the best of our ability speed is always our friend. Speed is always everybody's friend. So, we were looking at our forward pipeline in the beginning of Q4 and we started the process of our FL8 CLO very, very early. So we were closing loans in Q4 while we were going through the rating agency underwriting process for FL8 the price in January. So if you look at the aggregate exposure of loans on our warehouse facilities, I would actually say from closing date to the issuance of FL8, it was probably the shortest aggregation period we've ever had. And to that point, we just priced approximately $1.6 billion, $1.7 billion of liabilities in December and January with two year reinvestment on both. We think we've positioned the company really well on the liability side of the balance sheet and should be able to take advantage of some of the volatility that we're seeing today.

Great. Thanks for the call. I appreciate it.

This concludes our question-and-answer session. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks.

Thank you for your time today. If you have any further questions, please give us a call. We look forward to speaking with you next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.