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

Good day, and welcome, everyone, to the Blackstone Mortgage Trust Fourth Quarter and Full Year 2022 Investor Call. [Operator Instructions] I would like to advise all parties that this conference is being recorded. And with that, let me hand it over to Tim Hayes, Vice President with Shareholder Relations. Please go ahead.

Thank you. Good morning, and welcome to Blackstone Mortgage Trust Fourth Quarter and Full Year 2022 Conference Call. I'm joined today by Katie Keenan, Chief Executive Officer; Tony Marone, Chief Financial Officer; and Austin Pena, Executive Vice President of Investments. This morning, we filed our 10-K and issued a press release with a presentation of our results, which are available on our website and have been filed with the SEC. I'd like to remind everyone that today's call may include forward-looking statements, which are uncertain and outside of the company's control. Actual results may differ materially. For a discussion of some of the risks that could affect our results, please see the Risk Factors section of our most recent 10-K. We do not undertake any duty to update forward-looking statements. We will also refer to certain non-GAAP measures on this call. And for reconciliations, you should refer to the press release and our 10-K. This audio cast is copyrighted material of Blackstone Mortgage Trust and may not be duplicated without our consent. For the fourth quarter, we reported a GAAP net loss of $0.28 per share, while distributable earnings were $0.87 per share. A few weeks ago, we paid a dividend of $0.62 per share with respect to the fourth quarter. If you have any questions following today's call, please let me know. With that, I'll now turn things over to Katie.

Thanks, Tim. The snapshot of this quarter's earnings comes down to 2 key numbers: $0.87 per share, our distributable earnings, an all-time record for BXMT and $0.94 per share, our net change to book value, reflecting the impact of our CECL reserve increase given the more challenging credit environment. The 2 are integrally related. The primary factor pressuring credit performance is also driving record income for our business. And that is the precipitous rise in short-term interest rates, 425 basis points over the course of 2022, the steepest tightening cycle in 50 years. They're also integrally related for our company. Our powerful earnings stream protects the lion's share of returns for our investors as we work through a credit cycle. Our dividend is delivering a nearly 10.5% current income yield, well in excess of the 3.5% impact on book value of our reserve increase. That dividend is well protected, 140% coverage this quarter, creating meaningful cushion against nonaccruals. It is recurring. We've paid it for 30 straight quarters. And when we out-earn our dividend, the difference is retained as additional equity, further offsetting the impact of increased credit reserves on our book value. This interplay will persist. Rates are still increasing, and the Fed has made clear that they will stay high for some time. This will continue to pressure credit performance for the most challenged real estate assets. At the same time, elevated rates drive outsized earnings power and current return, a powerful hedge for businesses like ours. The broader market has figured this out. After a year of massive outflows from all sectors, inflows into fixed income so far in 2023 are robust. Credit assets are inherently defensive and floating rate credit is even better today. This does not mean we will be immune from an economic slowdown. Few businesses can be, but we believe our business is well positioned to withstand it. We start with an asset base of loans made to best-in-class borrowers with significant subordinated equity. With the benefit of insights gleaned from the far-reaching Blackstone footprint, we then built up our defenses for a more difficult environment. Having seen cracks in the capital markets, we shifted BXMT to a more conservative posture at the outset of 2022. We raised the bar for our lending activities, focusing on our highest conviction themes and top tier borrowers. We raised over $1 billion of corporate capital accumulating a deep well of liquidity. And we proactively worked with our existing borrowers to collect paydowns and recourse, reaping the benefits of our well-structured loans to enhance our credit cushion, while importantly, maintaining constructive relationships. At the same time, the impact of rates on carry costs, valuations and market liquidity will continue to weigh on the most vulnerable assets. This is an important concept. The impact of the current economic and interest rate environment on real estate is uneven. Income growth in multifamily, industrial and hospitality assets remains robust and supply has become more constrained due to rising construction costs, providing a longer-term tailwind to fundamentals. Capital demand is even more concentrated in these fast-performing assets, providing strong support to valuation. On the other hand, office is facing well-known headwinds from post-COVID work patterns and the slowing economy. But here too, the outcomes are uneven. The segment is not monolithic, and basis and quality matter. There is scarcity in true Class A office space as evidenced by record-setting rents at trophy assets. Meanwhile, commodity office in cities that were already experiencing slowing growth prior to COVID are facing the sharpest headwinds. Our reserves are concentrated in these assets as are the bulk of our asset management efforts. The 4 loans with new specific reserves this quarter date back to well before COVID, 2017 on average on assets that were well suited to their markets at the time. But COVID was not in the model and 3 of these loans are backed by office properties that are bearing the brunt of the post-COVID realignment in demand, most notably a significant reduction in government tenant office utilization. The loans also share the commonality of a material change in sponsor wherewithal towards the assets. We're sober about the value declines impacting the most challenged of commodity office. On average, our reserves are 20% of our loan balance and imply asset value reductions of nearly 50%. But these assets are not typical of our broader office portfolio. 54% of our office loans are backed by assets that are newly built or recently substantially renovated with an average vintage of 2021 at an average origination LTV of 60%. 34% of the office portfolio, most of the remainder, carries one or more significant credit enhancing qualities, such as particularly low leverage, high debt yield, location in high-growth sunbelt markets or material additional sponsor equity commitment in the last year. Our 4 and 5 rated office loans round out the rest and represent only 5% of the overall BXMT portfolio, a small fraction where we have meaningfully increased our reserves to account for the credit challenges we see today. Our overall loan portfolio is 97% performing. This year, we collected $3.7 billion of repayments, nearly 50% of which were on office loans. Our borrowers contributed $675 million of incremental equity, continuing to invest in their assets. We captured nearly $350 million of partial paydowns or increased recourse on 17 existing loans, primarily office, resulting in an average 16% reduction in our basis. We were able to negotiate this deleveraging because our loans carry many structural protections, performance tests, cash flow sweeps, guarantees and rate cap requirements. And of course, the most important protection for a lender is leverage plan. The insulation provided by our loan basis should not be overlooked. It would take lasting declines of 30% to 40% in real estate values for us to experience a loss at our position in the capital structure. And because the vast majority of our sponsors remain committed to their assets and have contributed more equity along the way, our business has been further de-risked over time, enhancing the embedded credit protection in our portfolio. In 2020, we encountered an unprecedented disruption for the real estate market. We addressed that challenge much as we are addressing the delayed COVID impact on office today, actively asset managing our loans, making appropriate risk rating and reserve adjustments, negotiating for credit enhancement and providing time where appropriate. It is our job as a fundamental investor to look past the broad brush sentiment and judiciously and proactively manage our portfolio based on Blackstone's deep experience taking the long view. And where the impacts of asset underperformance, capital markets and sponsor behavior combined to create a workout dynamic. We have the experience and the infrastructure as one of the largest owners of real estate in the world to identify and execute the best path for value preservation over time, a differentiator that will become increasingly important through the credit cycle. At the same time, we believe the origination environment will become still more opportunistic as values adjust and new capital is needed. We started the Blackstone debt business in the GSE, and we are uniquely positioned to access the once-in-a-cycle capital relief trades that create outsized returns on well underwritten risk. In the current market, we have found pockets of attractive regular way lending opportunities as well, exemplified by our nearly $700 million of second half originations that were 70% industrial, with yields 173 basis points wider than our overall portfolio. But with transaction activity far below the norm, the addressable universe of standard new originations is smaller. And to stand up to the opportunity cost of our capital, new deals today must be more attractive from both a risk and return perspective. Most importantly, the outstanding earnings power we've already established with our existing portfolio means we can well afford to be patient. As we look ahead, the market outlook is mixed. We see some green shoots with the turn of the calendar. The CMBS market has reopened with AAA spreads retracing 50% to 75% from historic wise in December. The corporate debt market is active. Banks having cleared their stress tests are fine. Stabilizing long-term rates create support for asset values and rational long-term borrowing costs, an important dynamic that should lead to more liquid markets. But there are still headwinds, the accumulating pressure of sustained high interest rates, geopolitical uncertainty, and slowing economies around the world. As a result, we continue to position the business to withstand a more challenging period while continuing to capitalize on the advantages that supported our performance this year, a well-performing portfolio, record earnings power, substantial liquidity and a well-structured balance sheet. While the coming year may present challenges, challenge creates opportunity, and there is no platform better placed to navigate this environment than Blackstone. We are the largest alternative asset manager in the world with unparalleled information, experience and relationships. We have a 4-decade track record of performance for our investors in all market cycles. And here at BXMT, we look forward to continuing to deliver for our shareholders. With that, I'll turn it over to Tony.

Thank you, Katie, and good morning, everyone. I would like to start by unpacking our financial results for the quarter. We reported a GAAP net loss of $0.28 per share and distributable earnings or DE of $0.87 per share. DE is up $0.16 from the third quarter, driven by continued income growth from our 100% floating rate portfolio as well as a notable prepayment fee of about $0.07 per share this quarter. Excluding this fee, our regular wave DE of $0.80 per share is up 13% from 3Q and 21% from the equivalent metric in 4Q of last year, reflecting the significant beneficial impact of rising rates on our portfolio. We continue to see rising rates as a tailwind for our business with a 100 basis point increase in rates from 4Q levels, generating around $0.05 per share of incremental quarterly earnings, all else equal. The primary difference between our GAAP net loss and DE is the $189 million increase in our CECL reserve this quarter, primarily related to 4 loans with specific CECL reserves as well as an incremental general reserve to reflect the broader market uncertainty and potential risk to our portfolio. Our aggregate asset specific CECL reserve now stands at $190 million or 20% of our 5 rated loans and our general CECL reserve of $153 million represents about 55 basis points of our total portfolio, which is up from 35 basis points last quarter. While these reserves will not impact DE unless and until they are realized, we have also placed our loans with specific CECL reserves on cost recovery status effective as of 12/31. These loans received all interest payments due in the fourth quarter and generated about $0.05 per share of interest income. However, as we collect interest payments in the first quarter of 2023 and onward, cost recovery accounting will instead apply the cash payments we receive against our basis in these loans. Ultimately, should these loans fully recover, all such deferred revenue will be recognized at the time of repayment. In the interim, this headwind earnings will be substantially offset by the benefit of rising rates I mentioned earlier. Continuing on the topic of credit. We upgraded 8 loans this quarter as performance for these assets continue to improve and downgraded 8 loans, inclusive of the 4 loans with asset-specific reserves I mentioned earlier. Our 5 rated loans with specific reserves represent only 3% of our gross loan portfolio. 10% of our loans have a risk rating of 4, all of which are performing and current and where we see the possibility of further stress of the economic conditions worsen. Remaining 87% of the portfolio is rated 3 or better. We continue to see business plans progress, including outstanding performance across many of our multifamily, industrial and hospitality assets combined represent over half of our portfolio. We have continued to collect 100% of all interest due under all of our loans, and the vast majority of our loans, 97% remain fully performing and recognizing income as usual. Although loan repayments remain muted, we did collect $648 million of repayments this quarter, roughly in line with our $690 million of loan fundings. Turning to our capitalization. We continue to run BXMT's business with a focus on balance sheet diversification and stability. During the year, we added $3.6 billion of new credit facility capacity with our key banking relationships, and we remain an important customer for them during a period when banks are increasingly selective on credit. None of our credit facilities allow for margin calls based on market-based valuations and 64% of our total financings are non mark-to-market, either structurally immune from any form of margin call or with mark-to-market either structurally immune from any form of marginal call or with mark-to-market provisions limited to defaulted assets only. Our liabilities are term matched to our assets, so we have no material corporate debt maturities until 2026. In the fourth quarter, we strategically upsized our term loan by $325 million, effectively refinancing the $220 million of convertible notes maturing in March and bringing our corporate debt raise to $1.1 billion for 2022. This incremental term loan was leverage neutral as we use the proceeds to repay revolving credit facilities. However, our reported debt-to-equity ratio did increase this quarter to 3.8x from 3.6x as of 9/30. This is not the result of increased leverage against our assets, but rather the result of our CECL reserve, reducing the GAAP equity used in these calculations. Excluding the impact of CECL, our adjusted debt-to-equity ratio is 3.6x, in line with 3Q and a level we generally expect to be stable going forward. Incremental capital we raised this year as well as the incremental earnings we have been able to retain, have grown our liquidity to $1.8 billion as of 12/31 or $1.6 billion net of our convertible notes maturing in March. This capital provides us with plenty of resources to manage our business during a volatile period and creates further stability in our balance sheet. Similarly, we believe our $0.62 per share dividend will remain stable and is well supported by the cash flow generated by our business. Our DE covered our dividend 116% over the course of the year and 140% this quarter, giving us ample dividend coverage and a wide range of credit scenarios. For example, in an onerous downside scenario where all of our 5-rated loans and all of our 4-rated office loans stopped paying interest, our 4Q earnings level would still cover our dividend with a healthy cushion, all else equal. Of course, we are not expecting this scenario to unfold, but it highlights the inherent resilience of our business and ability to maintain dividend stability. We look forward to continuing to deliver consistent, reliable current income for our stockholders, and we maintain our focus on stability and downside protection amidst a more challenging environment. With that, I will ask the operator to open the call to questions.

[Operator Instructions] And the first question is coming from Doug Harter with Credit Suisse.

Katie, hoping you could talk a little bit more about the 4 loans that you put reserves on. Kind of what specifically kind of occurred in the quarter that kind of led to that -- the downgrade and specific reserves?

Sure. So the loans that we added specific reserves this quarter were 3 office loans and 1 very small rent stabilized multi loan. We previously had them on the watch list and talked about a few of them last quarter as areas of concern. They -- we've had general supportive sponsorship behavior. And as Tony mentioned, all of these loans have been paying interest. But we're in a dynamic environment and the performance of these loans has changed over time. Some of the office loans, which are the lion's share are in some of the most challenged markets, D.C., Long Island City, Orange County. And I think also worth noting the quality of these buildings is quite distinct from the norm in our portfolio. There are generally more commodity buildings. We made the loans knowing that at low leverage points because they were relevant to a specific niche of the market that has now changed materially. So the setup of these loans became more challenging in the post-COVID world. And then that, combined with the impact of higher rates on carry costs and liquidity, combined with some upcoming maturities, created a decision point, and we made the decision to move those loans to 5 and take the specific reserves. We're actively working on these loans to resolve them and bring them to a conclusion. And as a reminder, the loans we downgraded are only 2.4% of the overall portfolio and really represent a different paradigm than what we're seeing in the most of the portfolio.

Just on the maturity point, Katie, I guess what are the kind of the final maturities? Or what would be -- or extension dates that could kind of trigger the next decision point from the sponsors?

So I think we're already in that conversation. You know, they have -- the office loans have their maturities this year. And so that's really part of what is resulting in these reserves and the conversations we're having. So there isn't another sort of impact or a relevant time line.

And our next question is coming from Don Fandetti with Wells Fargo.

Katie, can you talk a little bit about how higher rates are pressuring borrowers? And can they handle much more if the Fed continues to raise? And are you able to give modifications and that type of thing to manage through that?

Sure. So I think that clearly higher rates and especially the accumulating impact of higher rates for longer, create pressure for borrowers. They make carry costs more expensive. They make the option value more expensive for assets that are already challenged. They change the perceived cap rate and certainly the higher rates and the overall Fed tightening is having a very material impact on liquidity. So those impacts are happening. I think it's important to note that even with that, we still have a 97% performing portfolio. So our assets are withstanding those impacts, which we have been selling for quite a period of time now. And I think that's a testament to the equity value in the assets and our sponsors view about the long-term value of the assets which we share. I think the other dynamic that you brought up, and it's really important, and I mentioned in my script, is that the impact of higher rates, it creates pressure on assets that were already more susceptible. But for the lion's share of our portfolio, it creates very substantial excess earnings, and that creates insulation in our business in terms of our ability to retain those excess earnings in book value, our ability to cover our dividend and our ability to work with borrowers if they have a viable business plan. And it's really just the significant increased interest cost that's causing the pressure. We have some flexibility there to put the asset on a better path allow it to manage carry costs a little bit more reasonably and get to the other side here. And the fact that having much higher rates and the result of that on earnings in our portfolio gives us substantial margin to be able to have those conversations and a lot of optionality in terms of putting these assets on the right foot to manage through this period.

And our next question is coming from Steve Delaney with JMP Securities.

Congrats on a strong report and obviously, a difficult environment. Curious on the $0.80 of distributable EPS excluding the $0.07 in prepays. I mean it was very strong $0.08 to $0.10 above consensus in your own third quarter number of $0.71. Was there anything -- other than the obviously, higher average LIBOR, was there anything unique or onetime in that number, such as maybe a recognition of some accrued interest that had been deferred? Just help us if there's -- if you really -- I guess my question is to Tony and to you, Katie, is the $0.80 a reasonable run rate for distributable EPS in the near term?

Sure, Steve. The short answer is, as you highlighted, the $0.07 is really the unique sort of onetime. And then the $0.80 that is the earnings power of the business is the impact of rising rates on the portfolio and the full performance of the portfolio. When you talk about run rate, I'd say the 2 things to bear in mind, which I highlighted on the call. On the one hand, we have some of the loans going to cost recovery that will cut against that. On the other hand, we have the benefit of further rising rates that will be a tailwind. Those happen to roughly offset. But if you're thinking about the go forward, those are the 3 things that I would think about is the $0.80 baseline and then those 2 variables going forward.

Great. And on the $1.10 boost to the CECL reserve $1.10 per share, about $180 million. Can you clarify how much of that -- I think there was certainly a specific, you mentioned the loans that had been -- 4, 5 loans that have been put on the cost recovery. But is there a material increase in the general reserve include -- embedded in that $1.10?

Sure. So the general reserve went from 35 basis points of our loans to 55 basis points, which is about like $0.13. So its majority is the change in the impaired loans. But -- excuse me, it's about $0.30. I misspoke. So the majority is the move in the 5 rated loans, but you do have the general reserve growing as well.

Yes. No, I think that's important because we at least can have some hope or expectation down the road in an improving market that some of that may revert to book value.

The next question is coming from Jade Rahmani with KBW.

I wanted to ask about multifamily. We're seeing negative new lease rent growth slowing demand. So it's a matter of time before renewal rents catch up in terms of magnitude of growth. And in addition to that, 1 million of multifamily units under construction, so a massive increase in supply will pressure multifamily fundamentals. This sector had the lowest cap rates, a lot of deals done even below 4% caps, and many of those deals have challenges with interest rate caps that are coming up. So what are your thoughts on multifamily? And how exposed do you think BXMT is to any credit issues there over the next 12 to 24 months?

Sure. Thanks, Jade. I would start by saying what we're seeing on the ground in multifamily is perhaps a little bit distinct and it may speak to the quality of the markets and the assets that are in our portfolio and more generally at Blackstone. While we do see some deceleration in the growth of rents. We are still seeing positive re-leasing spreads. And I think you alluded to it a little, but it is really critical to focus on the fact that the loss to lease in these rent rolls is still very significant. So even if you see top line market rents decelerating or flattening out, there is still significant loss to lease that will create positive NOI growth going forward. And that's what we've seen. I think the other important thing to note is if you look at the vintage of origination of a lot of these loans, the real question is, where is NOI going to be relative to when we originated these loans and there's still a lot of growth between those 2 things, which supports our basis. I think the other thing to focus on, and again -- and supports DSCR and other cash flows. The other thing to focus on is there's a tremendous amount of capital that is focused on multifamily. There's been new capital formation focused on filling some of the gaps in the capital structures that may be caused by interest rates or rate caps rolling off or other needs. And generally, I think multifamily owners are very positive about the long-term prospects of their assets. The market in general is supported by the agency financing market. And I think as a whole, the combination of continued positive, albeit, to your point, probably somewhat less quick or decelerating growth, but continued positive growth combined with the fact that there's a lot of capital markets interest and support for this asset class makes us as a lender feel very good about where our loans are relative to the NOIs and the values of these assets. There will be a little bit of a pop near term in supply. But beyond what's already in the ground this year, the supply pipeline is really very significantly falling off. And so I think people will also see through an interim sort of short-term delivery of some of the assets that are under construction and understand that over the next couple of years after this, there's going to be very little new supply.

On the office side, as I go through the portfolio, there's many markets where we're seeing pressure. It's extremely widespread, including markets like Austin, Nashville, parts of Dallas and then the other obvious markets. So how confident are you that your fourth quarter CECL reflects a broad view of the office exposure and that we shouldn't expect material degradation in credit on that portfolio in the coming quarters?

Yes. I think a lot of it comes down to quality. I mean we're in a dynamic environment, so we look at the data and the trends we see today, and that informs what we do with our reserves and our overall risk rating process. And we've identified the 5s and the 4s where we see more susceptibility. But I think in particular, with some of the markets you mentioned, there's really a difference in the dynamic between San Francisco and in Nashville. There's still growth in Nashville. It may be coming down a little bit. But you think about rents and mark-to-market of where those assets were renting out historically versus today and the overall fundamental long-term dynamics. Combine that with the quality of assets we're focused on in Austin, our large office there is going to be the newest office building in the market. It's a mixed-use project, 62% of cost with an outstanding sponsorship. And it's really going to be the most premier asset in the market. And I think that's part of why we feel good about the overall office portfolio. It's really looking at quality. We're seeing in most markets is just this continuation of an accelerating flight to quality. And so you'll see the larger market statistics and certainly, they have challenges. And our portfolio is not immune from that. That's why we have the 4s and 5s. But by and large, the very high-quality assets in the market, we broke our sort of new and recently constructed at 2015 vintage. Those assets are seeing very different dynamics. They're seeing good net absorption, growing rents, a 5- to 10-point differential in availability. And while the overall market is slowing, those assets we think are going to continue to outperform.

And the next question is coming from Eric Hagen with BTIG.

How would you describe the approach to reserving and even potentially modifying loans because of the fact that price discovery is so weak in the market right now? And like how do you handicap for that in cases where you think there could be more meaningful discrepancies between where you think value sits and where sort of the unknown of where it could realistically transact?

Yes. I think for office, we are in a very liquid market. There's not a lot of transaction activity that's going on. The small amounts of transaction activity are generally in the more distressed category. And so I think it's fair to say no one can be perfect in that context. But that said, we have an extremely rigorous process. We do a full deep dive underwriting in coordination with our broader real estate team using all the best available information we have on our assets on the market, all of the constant information flow we have coming into Blackstone, both transactions that have occurred and transactions that have not occurred, and we informed that all through our process, which has been thoroughly vetted by our senior leadership. The reserves also go through an audit process. So there's a third-party auditor element to it. And so it's an extremely rigorous and detailed process that we think reflects the appropriate level of reserves that we see today.