Blackstone Mortgage Trust, Inc. (BXMT) Earnings Call Transcript & Summary

[Audio Gap] Cyganovich with Citi Research. Pleased to have with us Blackstone Mortgage Trust. We've got CEO, Steve Plavin. This session is for investing clients only. If the media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the Disclosures tab. For those of you in the room, you can sign in at liveqa.com and enter code Citi2020 to submit any questions that you have or you could just raise your hand. So we'll just start with Steve, if you could just introduce your team that you have with you today, and then we'll get into some Q&A.

Thanks, Arren. Hi, this is Steve Plavin. I'm the CEO of BXMT. And I'm joined by, from left to right, Weston Tucker, who is Head of Investor Relations for both Blackstone and BXMT; Katie Keenan, President of BXMT; and Doug Armer, EVP of Capital Markets.

Maybe we can just start off, if you could just discuss maybe how you can -- how you characterize the CRE lending environment today versus where we were last year at the conference.

Last week or last year?

Last year.

I think absent the unique circumstances around coronavirus, I felt like market conditions were relatively similar this year relative to last year. I think we felt the same seasonal pattern in our originations, which really means that the loan demand, the activity of our borrowers was consistent year-to-year. There's a lot of capital raised in the private equity opportunistic and value-add funds. The investment of that capital drives our loan demand. And we were seeing consistent investment of that capital through the year and going into 2020 as well. I think the spread environment was also was relatively stable, maybe with a trend of tightening. But we were seeing the market conditions that work extremely well for our company, which is consistent loan demand. Access to capital markets was very good for us and we improved the right side of our balance sheet. So the opportunity to fund new loans and generate the same kinds of returns we've been generating historically and grow the balance sheet in the business.

You've done a great job of growing over the past couple of years. You're at about $18 billion, the most of overall portfolio, about $16 billion on balance sheet. We've -- as you get larger, I imagine it's going to be more difficult to grow. Do you expect that you'll be able to grow net of repayments? And maybe if you could just talk about what's the optimal size that you would think the portfolio could go to.

Well, certainly, our objective to grow. We've been able to consistently grow sort of year-over-year. The percentage growth is -- will decline, but the absolute dollars of growth, I think, can still be very meaningful to the business. And we're -- as the balance sheet gets bigger, we're able to do -- make larger and larger loans. Our average loan size now is about $230 million. And so we're able, with our staff, to still grow the balance sheet. And we haven't grown the loan count a lot. We've just grown the average loan size. And for us, the larger loans are really one of the -- one of our competitive advantage is the fact that we have the balance sheet and the ability to fund them. And also because of the affiliation with Blackstone, and Blackstone tends to own larger real estates in the markets that we're active as a lender, it's where the synergies work best. So we feel like we have special insight into the larger properties in the more major markets. And in our experience, the bigger buildings generally -- the bigger loans generally translate into better quality real estate, better sponsors and better markets.

I guess that last point on the size of the loan, that's something that kind of stands out to me because you have some -- a couple that are very large, I think, you have like a $700 million-plus loan. Is there -- whenever we discuss this with other banks that make large loans, it's just -- people get a little uneasy about the potential risk of a single credit. You think that there's -- maybe you could just describe the safety you have under those very large loans that you're underwriting.

Well, I don't think we underwrite the large loans differently than the smaller loans. I mean as a lender, you want to avoid binary risks and you need to analyze the risks of the creditworthiness of the tenants and make sure you're not exposed to the fate of a tenant that you're not comfortable with their credit. And so we underwrite the larger loans and the smaller loans in a similar fashion. And if we feel like we're overly exposed to any kind of credit characteristic in the loan, then we either adjust the loan structure for it or we pass in the loan. And so I don't think the larger loans necessarily have any more of that risk than the smaller loans. It's just, in proportionate, larger. But what is clear, again, is -- the bigger buildings only exist in the major markets and the larger assets tend to be owned by better capitalized sponsors, and the real estate quality just tends to be better. And we think those markets, those assets, those sponsors will outperform over time. And we do have the ability in our underwriting and our analysis to know which loans to pursue and which loans to pass on.

That point about the sponsors, that always kind of also makes me think about the fact that there's been so much equity raised over the past few years, and certain firms are raising a lot each month. I was wondering if you could just comment on how that changes the dynamics of folks always wanting to put money to work. And whether or not that changes the value and supply dynamic as if there's always a bid for assets.

It's an interesting question. And the -- we're -- not all of the vehicle -- the vehicles that we tend to finance have -- usually have periodic capital raises. They draw down funds, and they raise funds every sort of 2 or 3 years and invest those. And they invest those funds and then go out and raise new ones. But the fundraising environment, whether it be in the non-traded REITs, which are raised on a regular basis or on the drawdown funds, which are raised more periodically. The trend has been more capital raised, more capital to invest. And that's just positive for us. It just -- it creates more lending opportunities where -- and we can meet the demand for debt of all those vehicles as we grow our vehicle. And so it's nice to see the growth in the capital base of the group of borrowers that where we're most effective as a lender.

Maybe you could just discuss the competitive environment today. Are you seeing mostly rational behavior from peers? And how would you characterize the number of bidders that you typically would see on the loan that you're underwriting versus maybe a year or 2 ago?

Sure. I think the competitive environment has remained pretty consistent over the last couple of years. There have been new entrants to the space. But I think one of the key elements of our competitive advantage on that large loan aspect that we were talking about earlier is when you think about quoting a $250 million loan, there really aren't a lot of new competitors at that loan size. Most of the competitors have tended to be focused more on the $50 million to $100 million area. And then we also have the competitive advantage of having been in the market for so long, having deep borrower relationships with 350 borrowers out there. It's just easier for people to come back to us and do a second, third or fourth loan with us relative to going to a new lender and trying to feel out how that relationship is going to be for the first time. So we continue to leverage that. And what we've seen is that, I would say, on a typical large loan, we are seriously competing with 2 to 3 people, and that's been consistent over most of our business.

Okay. Are you seeing any banks that are dipping into your market at all? And maybe you could just talk about -- you've underwritten some kind of fully leased-up properties as well and how you compete with the banks for those.

Sure. We see the banks, I would say, competitively in 2 main ways. One, some of the more opportunistic banks, Goldman, Deutsche Bank, for example, sometimes dip into the transitional lending space. But in many cases, they're a lot happier to finance us as the lender as opposed to competing directly, and that can actually be a very strong dynamic when we're trying to compete for a loan. We also see them in the CMBS space from time to time, especially in those more stabilized assets that you're talking about. And the CMBS market has been very price competitive over the last year or 2. The nice thing about our business is, because we're making primarily loans on transitional assets, and therefore, there's a business plan, there's a lease-up strategy, there's capital investment, most of those loans don't lend themselves well to the CMBS market. And even the ones that are a little bit more apt to be done by the CMBS market, most of those borrowers are still very focused on having the type of flexibility and relationship with their lender that allows them to implement their business plan. It's very hard with a transitional business plan if something doesn't go quite right, to deal with it in the context of a CMBS loan. And so our borrowers who tend to be experienced, have had experience borrowing from the CMBS market, know that for 20 basis points, not having the ability to change something during the term of the loan is an issue. And so when we're competing head-to-head with CMBS, that's where the conversation goes a lot of the time.

We've heard of -- and maybe not in this asset class, but private nonbank lenders that might have a lower return hurdle than you might. Have you seen anything from a competitive standpoint from other nonbank lenders that are private, kind of getting into your market?

Yes. I think that the interesting thing to think about from that perspective is there's the return required on an asset, on the loan itself. And then there's the return we're able to derive by using our rights out of the balance sheet, the liability structure that we have designed to really drive the ROI and therefore, the return to our investors. So while there are definitely private debt funds out there that may be targeting a lower face rate on the loans, they just don't have as much efficiency in the capital markets side, and Doug should speak to that. But over the last couple of years, we've been a huge innovator in being able to access the best types of capital for our business and really drive down our overall cost of capital.

Yes. I, obviously, agree with that. I mean I think it again goes to the scale of our balance sheet. And at the scale of our balance sheet, significantly larger than those private market competitors, who are not able to issue premium equity and who're not able to issue the term loan B that we issued earlier last year or necessarily able to execute the CLO financing at the same scale and efficiency that we're able to do. And obviously, we've also expanded our recourse credit facility relationships very significantly, and those also benefit from the scale and Blackstone connection that a lot of those competitors don't have.

Yes. And it gets back to the earlier point in that in the larger -- we don't see those competitors in the larger loan space. Maybe those vehicles will grow over time. But for now, they're not our competitors on the larger loans that we do, which is really our primary focus.

We got an investor question. How do you see spreads trending in light of the big move in LIBOR of late? And how have spreads trended year-to-date prior to the recent LIBOR move?

So I think prior to 2 weeks ago, we were seeing relative spread stability and maybe a little bit of a downward trend because of the competitive environment. But really, 1.5 years ago, there was significant pressure on spreads, and it mostly leveled off. I think the compression we're seeing on spreads earlier this year was really a derivative of how active the capital markets were, and a lot of us and our peers going out, accessing the CLO market in other ways to kind of tighten up our cost of capital. I think what we'll see going forward, and we're already starting to see this a bit is, I don't think there's going to be as much pressure on spreads because of the volatility. Seems like, at least for the near term, we're going to be seeing a pause in spread compression, maybe more volatility in spreads generally.

Okay. Another question we have is coronavirus is devastating travel and leisure. What does that mean for the performance of your hotel loans? And will these deals get permanent financing in the current environment?

Well, I think obviously, the coronavirus is negative for hotel performance, and it's really a matter of which hotels will be impacted and for how long. And I think the presumption is it feels now like it's going to affect hotels almost everywhere, inevitably, to some degree. For us, I think our hotels are very significant assets with strong sponsors. We expect continued credit performance through the course of the virus. It's consistent with how we lend against the other asset classes as well, which is again, the more significant sponsors, more significant assets in larger markets. And so we're dealing with sponsors and vehicles that are capitalized to get through a difficult time. And so we do anticipate a lot of stress in that asset class, and we expect our borrowers to continue to perform through it.

[indiscernible] on your development story, what percent of these construction loan growth [indiscernible]?

Yes. We have no hotel construction loans.

Maybe we could touch on CECL. You had a pretty modest reserve build, it was about 11 basis points. And when I look at your peers, the peers kind of came in more like in the 30 basis point range. Is there a difference, do you think, between you and some of the other REITs? Or do you feel like there might be some modifications to your CECL over time?

I'll take that. There is a difference, I think, between us and our other peers. And then, again, goes back to the fact that we're running a somewhat different business. Our focus on very large loans in major markets is different than most of our peers. And if you look back at the historical data, the performance of those -- let's sort of analogize them to SASB and CMBS loans as opposed to conduit CMBS loans, has been significantly better. So we think that our reserve accurately reflects the lower credit risk in our portfolio of very large loans in major markets. The data backs that up. And obviously, our auditors and regulators agree.

Has there been any impact in the market that you can see thus far from CECL requiring a little bit more capital and requiring changing the dynamics of the -- at least, the GAAP reporting of your income statement?

We haven't seen any yet. I don't expect it. I think the actual credit performance will be much more meaningful than the CECL reserve.

I think that, again, goes to the difference between our business model and maybe the business models that where CECL has been adopted more broadly. But if you think about consumer lending, more residential mortgages and other types of sort of more granular actuarial underwriting as opposed to our very specific, case-specific underwriting that Steve referred to on our very large loans, I think in those areas, you'll see an impact from CECL. But in our business, we haven't seen that impact, and we wouldn't expect it just given the somewhat swear pay rental application.

Okay. We've got another investor question. If you think spreads may stabilize or even widen due to capital markets volatility, are you more apt to ramp up loan production in the near term?

I do think that this -- with the volatility, there's a much greater likelihood that we'll see spread widening as opposed to spread tightening. Obviously, CMBS will -- the CMBS spreads are for the loans that don't get pulled, the spreads will clearly widen out because in conjunction with the movement in bond spreads. So the private market tends to react a little bit more slowly than the capital market for loans and loan spreads. But I do think you can also potentially see a rate cut and lower base rates, which I think will also argue more for wider spreads. So I think there's a greater likelihood that spreads will widen from here as a result of the volatility.

In the production side, do you think that would be impacted by that?

The way I look at the production side is that in periods of volatility, the buyers and sellers tend to temporarily move to the sidelines, so transaction volume temporarily slows while people wait for the markets to reset or to decide they have enough conviction to either buy or borrow. So that tends to be the pattern, I expect that to be the pattern this time as well. So we may see a little bit of a drop-off in the activity from our borrowers and then we have to decide how we feel about the certain market conditions. I think it'll be asset-specific and borrower-specific in terms of how we feel about opportunities now versus how we felt about them a couple of weeks ago. And so I think our inclination will be to try and get a sense as to test the world a little bit wider. If we see opportunities that support our clients in good loans, we'll be there for them for sure. And the stuff that's lower spread on the margin that felt more commodity like, we'll reassess.

Let me touch on the LIBOR floors that you have. I think you have about -- a little over 1/3 are active. What proportion of the portfolio do you have floors already built in? And maybe you can talk about, on new production, are you able to put floors at similar levels as you're typically doing this at their production rate? Or are you actually getting pressure from borrowers now to change them?

Maybe I'll take the first part of that and then flip it to Katie. We do have LIBOR floors in all of our loans. And there's a dispersion of levels that -- to your -- the latter half of your question relates to where LIBOR was when those loans were originated. And we think that given the complexity in our balance sheet and our positioning versus interest rates generally being a match-funded floating rate funding, the best way to look at that is in terms of our net exposure to LIBOR, giving them floors to place in. We have a very, we think, easy to understand exhibit in our earnings release that shows our sensitivity to LIBOR, both on the way up and the way down, giving those floors significant decreases in LIBOR will actually result in increases in our net interest income and also to our core earnings. And that effect is most significantly pronounced or decreases a lot more greater than 50 basis points. Right now, we're -- given the shape of the curve, if you will, in terms of the LIBOR floors, we're more or less in a sort of neutral position versus further decreases to LIBOR until we exceed -- if we exceed the 50 basis point decrease at any point, it's actually a benefit to our earnings.

And I would say on the new origination side, LIBOR floors are very much at the forefront of our originators as well as everyone else in the market. It's very market standard to have them. There's certainly a negotiated point, just like spread, in every environment. But I would say, consistently over time, we try and get LIBOR floors that are a little bit below where current LIBOR is. So if LIBOR keeps falling, we would expect the actual floor rate we can set to go down a little bit. We're not going to be able to set in the money floors at closing or above current LIBOR, but we have been very consistent in maintaining LIBOR floors in our originations over time, including right now.

That benefit that you talked about, Doug, about the essentially kind of V-shaped, a benefit to up or down in LIBOR. Where does that change so that as your older loans are paying off and those floors get paid off? Is there -- there has to be some sort of a reset eventually.

Yes.

Is there a net negative, kind of like if rates stayed at a lower level for a longer period of time?

All else equal, there would be. I mean I think the pace of that recycling, if you will, is going to be affected by whatever the underlying sort of factors are, resulting in the rate changes. So Steve mentioned that we would expect repayments to slow in a period of significant volatility. So if there's a big rate cut in the near term by some of the market concerns that are present now, we would expect that recycling pattern to operate much more slowly than it has in the preceding year or 2. So that I think it's an important dynamic. The other more medium-term dynamic that we expect to play out also would be the inverse correlation between spreads and LIBOR that Katie referred to previously. So an extended period of significantly lower LIBOR, I think, would result, obviously, in cycling into portfolio with lower LIBOR, of course, but presumably also higher spreads. And again, if that's accompanied by a significant economic stress where we essentially expect spreads to be wider, in the same way we would expect LIBOR to be lower. We saw that dynamic play out very much in Q1 2016, for example, through 2016, we've seen it historically really back to improvement [ in order to regain our business ].

We got another investor question. How far above market are the spreads on your loan book currently? In other words, if loans were re-originated today at current market pricing, by how much would the spreads go down?

It's a good question. I would say, really, because the decline in LIBOR was so much more pronounced 1.5 years ago than it has been in the last year, that dynamic has really worked its way through for the most part. The other thing to keep in mind is that while vintage loans, loans we originated 3 years ago may have a higher spread, they also attracted financing costs that was commensurate with that spread at the time. So it's really important to look not just at the loan spreads, but also the ROI or sort of the leverage spread that we're able to achieve in our loans. And our cost of leverage, really, for the most part, moves. It's a little bit of a trailing indicator, but it moves in lockstep with our -- the rates we're able to achieve on the whole loan. So from that perspective, the ROI we've been able to achieve on our loans has been quite consistent over time. And I think you can see that in our earnings.

Great. Okay. Maybe just -- you touched on the fact that the financing has been very positive for you recently. You've done CLOs. How does the recent kind of hiccup in the markets, how does that impact your ability to finance? And are we going to just see a change from the benefits that we've had recently?

I think it's different for different elements of our strategy. And one of the great things about our balance sheet is how diversified it is in terms of our sources of funding. So we aren't dependent on the CLO execution. For example, we're very happy with the execution that we got done in the first quarter of this year. But we do maintain relationships with more than a dozen banks of bilateral credit facility relationships. And those are very insulated from the capital markets vendors that I think affect the more securitization-oriented financing strategies. So I would say our access to debt capital, in particular, remains very strong from a very diversified set of potential sources that really run the gamut from structured finance, securitization alternatives all the way through to recourse credit facility-type relationships and onto the corporate side in terms of the term loan B and other corporate alternatives.

Can you remind me, did you close the -- I think it was a CLO that you're working on around the earnings call. Did you end up closing that? Or is that...

We did. That settled, I think, a couple of days after the earnings call.

Maybe you can just talk a little bit about the property types. I know it's kind of tough today, but what property types are you favoring to finance today versus maybe even a couple of weeks ago?

I think we still see the most opportunities in our business model in the office sector. It just sets up best for our lending. Again, it's the asset class that is most frequently acquired by the fund sponsors that generate our loan demand. When an office building loses 20%, 30% tenant, it immediately becomes a transitional asset. And especially if it trades for an institutional owner to a private equity sponsor, then it becomes the ideal target for a loan from us. So we still see the most loan demand in that sector. And we like office in the markets where we pursue it, which is, as Katie mentioned before, the knowledge center markets where there's dynamic tenant demand from technology or life sciences or content creation, those are the markets where there's real tenant -- where there's real growth. They tend to be the coastal markets. And again, because of where we want to be loan size-wise, we're really only active in those major markets that generate -- that have real estate that sort of value tip of $300 million or $400 million. Once you get out of the top 15 or 20 MSAs, there's not that much of it. And so it also itself selects to strong sponsors, dynamic markets and bigger assets. Office is still the asset class that we see the most of, but we're active in all the main property sectors. I mean hotels would be a little bit tougher today. Very active in multifamily and we found some industrial to do. We've done virtually no retail. We're down about, what, 1% or 2% retail. We continue to look at retail opportunistically, but we haven't made a single and closed regional mall loan in the history of the company. And haven't seen that sector create opportunities that would warrant sort of venturing there quite yet, maybe at some point. So I think we're opportunistic on the property sectors. We cover the main ones. We don't tend to do a lot of specialty property sectors. And again, the focus remains primarily on office.

Okay. ESG has been an increasing importance for all companies and stakeholders. Maybe you can talk about what one thing your company is doing to improve your overall ESG score over the next 12 months.

Yes. Arren, let me take that one. So ESG has been a critical area of focus for Blackstone for a long time. It's one of the investment vehicles of Blackstone. Obviously, all the policies and the framework of ESG that Blackstone applies, applies to BXMT. It's integrated [ to the new ] process, it's integrated to portfolio management, and it's really around the world across the businesses. I think what we've done really well from the Blackstone side has been disclosing sort of what we're doing and talking about what we're doing in [ the current private market equities ]. What we haven't done probably as a bit of a job of is public disclosures on Blackstone side and on the BXMT side. Those are areas where we're talking to our shareholders, we're trying to figure out what types of things they want to see, how we can better illustrate all, everything that's going on across the portfolio, across the different business lines. [indiscernible] as well just talking about a lot of policies and things that we do and what the requirements are. So I think there's more to come, but let's see right [ where we're going to stop ].

Okay. You've really increased the amount that you've invested outside of the U.S., I think it's at about 34% today versus around 19% last year. Can you just give us an update on the international investment opportunities and the risks that you were kind of managing as you invest outside the U.S.?

Sure. I mean we've essentially been able to export our cost of capital and some of the good work that Doug does almost everywhere we're able -- where we lend. And everywhere we lend, we also own. So we have the ability, I think, and it's a differentiated ability, to be a lender in many areas of the world. We focus on the regions that create the best lending opportunities for BXMT. We have -- we did see a shift over the last year or 2, where the better relative value opportunities were in Europe as compared to the U.S. So we've seen for comparable risk, spreads a little bit wider and our -- and we've had an ability to generate either higher returns or similar returns with lower risk. The big difference between the lending activity we do outside the U.S. and with -- in the U.S., is really the frequency of the opportunities. It's still more episodic outside the U.S. The regular way loan demand is generated with a greater frequency and a greater pace in the U.S. There's more fund sponsors looking to buy more assets, there's this more real estate and there's a greater acceptance of buying, fixing, selling and financing that plan with floating rate debt from lenders like us that create an ability to finance their business plans and then have a good sale win though at the end when the plan is complete. We've really created a lot more awareness outside the U.S. for what we're able to do. Some of the fund sponsors that we're active with in the U.S. have Europe vehicles as well. We have a very fully staffed origination office in London, and our footprint in Europe is as big or bigger than our footprint is in the U.S. So again, benefiting from the global reach of Blackstone. So we have seen a lot of great opportunities in Europe. We hope -- we think we'll continue to see more. We have a great team there. We also have some originators in Sydney as well and have been active in Australia. Again, a smaller opportunity, but one where we've been able to export our cost of capital in a market where there's -- spreads are a little bit wider. And there's a growing opportunity for lenders of our profile, or let's just say, with transitional assets and sponsors willing to see a little bit of leverage to achieve business plans. So I think the global nature of our business is something that's an important difference between us and some of our competitors, gives us a much broader canvas and more opportunity and the ability to redirect to those regions that have the best opportunities.

Okay. Maybe just quickly, something I couldn't find specifically in your financials as well. What proportion of your book is in construction loans?

Yes. It's under 10% in terms of principal balance. The thing about construction loans is, although we have some large loans, they draw over time. And so the outstanding exposure of construction loans in our book historically has been 5% to 8%. And it really never picks up much more beyond that because they drop over time, and then they payoff at the point that they're most strong very quickly. So it's not a huge impact in terms of our overall portfolio investments, although they are very good credit opportunities from our perspective.

Yes. Typically on the construction...

And [ outsized rates ].

On the construction loans, the equity usually gets invested first. So sometimes at loan closing, there's no outstanding balance and the sponsor's still investing equity. The low and mid of The Spiral at Hudson Yards, this is about a 2-year period of equity investment where there's $2 billion of equity going into the deal. And so they're really, really strong credits. I think they're as strong as any credits in our entire book. And the challenge is growing the outstandings and holding on to the deals after they're complete. So I don't think that will ever be a large portion of our book, but it's -- the portion it represents is -- performs extremely well. And we've had great experience, and the new assets have been incredibly well received by the market.

Great. All right. Well, we've got a few seconds left. So thanks so much, Blackstone, for joining us, really appreciate it.