BrightSpire Capital, Inc. (BRSP) Earnings Call Transcript & Summary

All right. Well, it's a busy day. So why don't we go ahead and jump right into it? I'm really excited about this panel. We have the team from BrightSpire. To my left is Mike Mazzei, CEO; to his left is Frank Saracino, CFO; and to his left is Andy Witt, CIO. Thank you, gentlemen, very much for being here. I'm Eric Hagen with BTIG.

Just to maybe set the stage and start off with a fairly simple question. Why don't you characterize for us the state and condition of the commercial real estate market and maybe give an overview of BrightSpire in general?

I'll start off and let my colleagues jump in. So BrightSpire has been a transition from what was formerly Colony Credit, which was formed by Colony Capital in 2018 as a merger of assets and 2 nontraded REITs. We bought back the management contract over a year ago and have become internally managed. And since this team took control of the company in the spring of 2020, in the midst of COVID, we've done a lot to transition the balance sheet. Initially, we had to burn a lot of furniture and sell assets to keep the house warm, so to speak, and sell assets at -- and some assets at prices that were a little bit distressed during the COVID environment. And so the company has made almost a complete transition since then where we've evolved a large percentage of our assets to first mortgages, which we actually started to do before my arrival. Andy started doing that in 2019 when we did our first CLO. We did our second CLO last year, and we continue to transition the balance sheet to first mortgages substantially, which have been multifamily, which was a soup du jour for the past 1.5 years, a year plus. Where we are today in this market? So right now, we reinstated our dividend. The team will talk more about some of the accomplishments that we've made. We've cleaned the balance sheet. We have a few pre-COVID assets that are still suffering from COVID, some office buildings. We have hotels that are starting to perform very well now that were in a trough during COVID. So we're optimistic about the performance of those assets. And we'll continue to address some of the pre-COVID assets, but we feel like we have substantially -- we have most of that behind us. I think what you learn here today is something you could also take through the entire Nareit conference because we're debt guys, we're debt folks. And the world has changed again, right? So we are now SOFR is going to go -- our new index that we price bridge loans on. SOFR is going to go to 2.5%, 3% with Fed funds over the course of the next several quarters. And when you add the lending spread, which used to be 300, but it isn't anymore, it's kind of closer to 400, you're talking about 6 handle lending rates. And that is going to change valuations, period, end of story. It's a very difficult market to lend in today, and Andy can talk more about the complexion of our originations and what the challenges are there. But we were all in multifamily with the market and all with the path of growth and migration from higher income, higher tax states to South, Southeast states. So Texas, Arizona, Florida, the Carolinas, we had a lot of focus on acquisition lending in those markets where we're seeing tremendous rent growth. So those markets will still have rent growth, albeit it will decelerate, but it's really the cap rate expansion that I think is going to change the game. It's going to put a foot in the door on asset sales because right now, the assets investment brokers are calling their sellers saying, "We told you, you can get X, but you're not getting X." And so that system now has to go in reverse. And the feedback loop goes back to owners and they're realizing, okay, the market's changed because of interest rates. What can we get? And do we want to sell it now? Or do we want to go to refinancing? So it could very well go from what was a hot multifamily acquisition market to just a refinancing market where existing holders aren't sellers at this point. So it's a very challenging market to lend into. I'll turn it over to Andy to talk about that because he lives it every day with our origination team. But between the CLO market, the banks and what's out there, it's -- we're spinning plates in terms of -- in the air in terms of where we can play and what we can do.

Thank you, Mike. So going into the year, we were pretty active on the back half of 2021, a number of those transactions closed early in the year. And then obviously, the market started to change. And so although we've been seeing a tremendous amount of product in the first quarter plus, we probably saw $50 billion worth of transactions across about 900 different distinct opportunities. What's actually coming through the funnel and is interesting to us is really becoming less and less. And it's really a result of the feedback loop that Mike just explained. The market hasn't adjusted. Investment, sales, pricing hasn't adjusted. And so the market has indeed slowed down. In terms of our portfolio, we aren't putting the capital out necessarily at the levels that we had anticipated going into the year. But what we're also seeing is a real significant slowdown in the repayments. So where we thought we might be seeing $400 million, $500 million of repayments in a particular quarter, we're seeing about half of that. And so as Mike had mentioned earlier, you're seeing more loans that are just staying put. You're seeing loans that are refinancing in certain cases. But in terms of new activity, it's certainly slowed down. Spreads have widened out. The index has gone up. Overall cost of funds is higher. And the market is adjusting. In terms of the CLO market, that's obviously been -- there's been some tough prints recently in terms of just where that's priced. Some of the -- at least the last 4 transactions have actually sold at a discount to par, which is kind of divergent from how the market usually functions. So that's certainly a dynamic that banks are taking note of and so forth. And so that's being reflected in our liability structure. So there's certainly an adjustment occurring in real time.

So if you're a mortgage REIT and you don't use the CLO market to finance yourself, you still are affected because the banks that help you issue those CLOs, they're providing the warehouse lines to all of the mortgage REITs and the debt funds that are out there. And they take notice that the AAA on a CLO is now like north of -- like a 2.75% spread for the AAA. And the AAA is akin to like a 40% loan-to-value. Based on the loan-to-value of the underlying loan and all the credit enhancement that you get between the first bond that takes the most risk to the AAA, when you add all that up, you really -- the AAA is taking like 40% loan-to-value risk. And that's getting priced at really attractive numbers, like SOFR plus 2.75%. At SOFR plus 2.75%, that index gets into the 2s and the 2.5s. So you're talking about short duration, floating rate, AAA paper that's yielding 5% or close to it, right? So that becomes very attractive, especially for investors that are afraid to venture out into the 10-year horizon fixed rate for corporate bonds or CMBS. So CLOs are very attractive. The banks take notice and the banks -- if you're not doing CLOs, the banks call up any mortgage REIT and say, "We can't have you pricing -- providing you credit at L plus 200 for a 20 -- 80% advance rate on a loan that's 75% loan-to-value when there are AAAs trading 50% wider or higher than that." So the banks also start to adjust their spreads. As Andy said, on the other side of the equation, our prepayments will slow. And so from a -- we're always watching net deployment, right? We want to get out net equity on and grow our balance sheet. So while we are pulling back and we're looking at those 3.5% cap rates saying, we can't lend on that today at excess of 3.5% collectively, which just -- it's not going to work. You're not going to get rents to increase as fast as cap rates are going to increase. So as we pull back on origination, we've been doing that in the first quarter, and more in the second quarter, we're getting worried from our borrowers that, "Hey, I was going to sell the property, but now I'm not going to sell it. And so let's hit the extension." So that will work in our favor as well. Then alternatively, and I'll turn this over to Frank, in terms of the use of capital, the market was getting its butt kicked and our stock price, which ended last year at 10.25, also came down dramatically over the month that we had some huge selling. And when we kind of went to the low 8s, we went back to our Board and said, "We've got extra capital here. We've done a great job at delevering the firm. We're traveling at a lower leverage right now, and let's get some -- a hallway pass to buy back some stock."

So we've been in the market now for over the last 2 or 3 weeks buying back stock. We announced and have approval from our Board for up to $100 million. And that's kind of our plan. The number for the quarter will get disclosed with our quarterly reporting, but we've been in the market and been executing on that plan.

And so it's pretty -- it's accretive. If you can -- if we had earnings that were in the high 80s, $0.90 a share, you start looking at a pretty good earnings yield to that price of where you're buying back the stock. And you start getting into 11% earnings yield, and that's the target you want to make on loans, it starts to become attractive. And you also with -- what's our book value now, Frank?

12...

$12.35 or something. You might be able to add $0.25, $0.30 to book value and put some earnings onboard and deploy that capital. We're going to be watchful of that. I opened up with, we started off burning furniture to keep the house warm in the crisis, and we aren't going to do that again. So we're going to have cash. We're managing the balance sheet to always have excess cash to take loans and move them around off of warehouse lines or out of a CLO in case we get into a little bit of a problem with a loan. So we'll always maintain liquidity. And looking at this, we were very careful to analyze that we'll have enough cash to get through the storm. We're not going to go into the market and sell some things. You are seeing some debt funds actually unable to place their CLOs and their banks are telling them, "We want you to lower your bank exposure with us." And so they're actually forced to go out and sell their mortgages or sell an A note. We're in no way in a position like that. We were thinking about doing a CLO this year, some of the CLOs that Andy alluded to. After doing the CLO, the ROE to the issuer was like sub 8%. Like we all know that this is like an 8% dividend yield market. So you can't have your assets giving you an 8% return before G&A. And so we saw competitors doing loans at very tight pricing and had so much accumulation of loans that they had to go to the CLO market because the banks were kind of pushing them, almost like walking the plank, pushing them to issue. And so they might have gone from what was an 11% ROE on a bank line to an 8% ROE in a CLO. And you can't do that. You may make that mistake once if you're very big, but you can't make that mistake twice. So we looked at that and we said we had ample cash, our warehouse lines have plenty of capital left on them. And so we pulled back and said we're not going to issue a CLO at this point.

That was a really helpful overview. I might ask kind of 3 questions here. One is, what do you feel like are the catalysts for spreads to tighten in the CLO market, in the market in general? The second might be, where are you concentrating new originations despite the fact that paydowns might be somewhat slower? And the third would be to maybe highlight an objective for earnings over time. You talked about the opportunity for accretion through stock buybacks as well as all the investments that you're making. So what's the objective for earnings?

I'll handle the CLO spreads and Andy can talk about what we're seeing and where we see the opportunities. It's hard. We're in a risk-off environment. And until we get out of this risk-off environment, I don't see spreads tightening. These CLOs are -- I thought they were compelling 60 days ago. They're screaming, compelling now because, as I said, short duration, AAA and you're going to go to 5%. And so where do you get that, right? It's a money manager's dream. We just have to get those folks to be risk on again. They are just starting to do that. There was a point in time 2 weeks ago, investor banks would tell you that they could not get investors to pick up the phone at all. And so deals were not even clearing. Now we're starting to see deals clear at discussing pricing, but we're seeing it. But that's the first point. So it might take another 120 days to see how much more the Fed is going to do, but we have to get into a risk-on environment, which right now over the summer, we don't see that in a big way.

So to answer your question on what the opportunity going forward is, I mean, as Mike mentioned, it's tough out there right now. There's not a lot of opportunities that we can make sense of or have made sense of recently. That's not to say that we're not finding the occasional loan, but it's really doing what we've been doing. And when you look at our portfolio, the underlying 110 loans, about 85% of that is in the top 25 MSAs. But more importantly, 74% of that is in markets that are growing at or above the national average growth rate. And so it's -- what we've been focused on is markets that have tailwind and markets where people are moving, where you're seeing the demographics where people want to be. And so as we look out there, those are the markets that we'll continue to concentrate on. Obviously, multifamily has been the most attractive asset class as of recently. We participated in the office marketplace as well and industrial. So we've seen a few opportunities in the industrial space recently. So it's very much rifle shots picking at the edges and just being disciplined right now.

And I'll handle the last question regarding earnings. So our quarterly run rate has been $0.22 and gets us about $0.88 a year. We will see some accretion, obviously, from the buyback. Our earnings are positively correlated to the [ Bryson ] interest rate. So we had a sensitivity we showed at the end of the last quarter, but essentially, at 2.5% for the benchmark, that will add $0.04 of annual earnings. And then from there, it's about the balance of -- getting the additional capital to work and balancing that against our level of buyback. If you're speaking, talking publicly about $1 a share and that remains our goal. But the key from [indiscernible] is really getting that extra capital to work. How that translates to the dividend? Obviously, the buyback and rising interest rates will increase our earnings, and we want to be thoughtful about raising our dividend. Our goal is when we raise the dividend, we don't want to have to then go back in second quarter and then lower the dividend. So an increase in our dividend, it's meant to last into perpetuity.

Let's definitely return to the interest rate sensitivity in just a minute, but in the meantime, address maybe the elephant in the room, which is the overhang related to DigitalBridge, which is your largest shareholder, and the expectation that it may eventually exit the stock And how you guys are thinking about managing that event.

Thank you. Well, so DBRG, formerly Colony Capital, when they -- I said when they formed the REIT, there was a -- they contributed assets and they took back stock. At one point, they owned 48 million shares of the stock. Now they're down to 35 million shares, which is about 27% of our holdings. We would prefer to buy the shares back directly from them so they can -- we can really drop that percentage. And our goal would be if we can get them below 10%, where they're free to sell the stock indiscriminately and not tied to our reporting and not tied to our window of when -- a blackout of when they can sell, that the market may give us a pass and say those shares are going to be gone, and it's no longer overhang, it's safe point of entry. It's difficult right now because you kind of feel like you're picking up nickels in front of a steamroller. If you're going to buy stock and then you have the seller come in the room and then -- with the secondary, if we -- and the stock drops dramatically to get that secondary done, if we could take part in the secondary, that would help. And I think there's a willingness on our part of it. But as Frank said, when the stock hit 8, we ran to our Board and said, "Let's do it." The management team bought stock. The management team has been getting stock. The management team has been buying stock. When DBRG did a secondary of like 10 million shares last year, when that secondary was done in place and cleared at 9, this team bought stock at 9.5 to show and to thank those investors who took part at 9 and to show confidence. This time around, the stock dropped again and management team bought stock themselves. We went to the Board and said, "Now we can't wait for DBRG. This is too compelling." And so we took advantage of that during that time frame. DBRG says they're going to be deliberate when they sell. And -- but at this point in time, we're not waiting for them. I don't have a time horizon for them. That's something you could ask them. They are deploying a ton of cash in buying assets to become more and more digital. This is listed in their supplement as a source of cash, below cash. It's cash and it's our stock as sources of cash for assets. So you think they would do something, but at this point in time, we did not want to wait.

Do you want to return to the interest rate sensitivity of the question?

Sure. I mean just some benchmarks. So our weighted average floors at the end of December were 88 bps and then it went down to 70 as of March 31. So when we had our earnings call in February, we were already north of that at around 80 bps. So our LIBOR is already in the money. And today, we're at about 112 or 116. We're getting close to a $0.01 a share pickup in that right away. And as I mentioned previously, getting to about 2.5% at the benchmark will earn us about $0.04 on an annual basis. So the rise in interest rates is happening. And older loans that are repaying, that is also helping.

Going back to the DigitalBridge overhang for just a second. If you guys were to participate in a buyback -- in a secondary with DigitalBridge, how would you manage the liquidity profile? Where do you have room on your funding lines currently to be able to manage that?

So I mean I can answer that. I mean we have -- at this point, still have available cash on hand as well. We also have a credit line that is unused. We get a lot of questions about would you do a preferred offering. And right now, Eric, I have a report from you that's saying preferreds are now trading north of 8%. So 8% nonqualified paper is expensive at this juncture, but it's obviously something we look at. At the time, it would just be hard to time it because the DigitalBridge called, and they were going to market tomorrow, we wouldn't be able to get a preferred done in time. So we would look to our liquidity, where we are in our buyback, evaluate the line and kind of discuss with the Board.

So most of the loans in this space are transitional loans. Can you talk about some of the business plans that come with loans being made in this market and how that might differ from some of the business plans you've encountered in the past?

Sure. So in terms of typical loan structure, it's 3 plus 1 plus 1, sometimes it's 2 plus 1 plus 1 plus 1, and these are transitional loans. And the underlying business plans, frankly, aren't changing, but what is changing is that the operators or the borrowers are going to have to execute their business plans in order to get the returns for their equity. And what we saw kind of coming out of COVID is a lot of folks were able to partially complete their business plans, so do 20%, 30% of what they had planned to do. And with kind of the tightening of cap rates and where the debt capital markets were, they would point to those data points and then move out of the asset and sell the asset. And so it was a very quick, high-velocity type of business plan. And now what we're seeing is folks are having to dig in and really execute their entire business plan. So instead of doing 20% or 30%, pointing to those data points and exiting the asset, they're going to have to grind through the entire business plan. And a typical business plan on a multifamily asset, for example, where we've been the most active is there's some sort of deferred maintenance CapEx program, some type of common area amenity improvement. And then the majority of the money is going into the units. So it's washer, dryers, counters, appliances, flooring and so forth. So I'd say about 70% or north of that is generally in the unit and the goal is obviously to push rents. And what we've been seeing, and you'll probably hear throughout this conference, is the increase in rent in the multifamily space has been dramatic. And that's just from re-leasing and then the combination of re-leasing and then executing on a value-add plan has been very accretive to owners. So those are the plans that we'll continue to fund. But I think people going into these -- taking on these projects have a view towards executing the entire business plan, whereas there was a view, I think, at one point where you could kind of get in and get out. So that would be a typical profile.

I feel like the unspoken theme at a conference -- this conference this week is that we're living through an inflationary environment and a rising interest environment. And so for a REIT, that obviously creates a little bit of a challenge or a headwind. What would you say is maybe the opportunity set for investors in a mortgage REIT right now?

I'll tell you what the opportunity set is for BrightSpire. This company went from a company that had very large private equity-like type assets that were hundreds of millions of dollars in size and very lumpy and has gone to almost an entirely pure-play first mortgage asset. And the assets that Andy described, our average loan size is $35 million. And so it's very diversified. Most of the financing we've done is acquisition financing. So in a rising rate environment, you have borrowers who are still going to defend capital if they get them on coverage. And you hate to go down this road. But every time we do an asset, we say, "Is this an asset that we can take back, okay?" Where there are many assets that were done by predecessors where we would say, "Oh, my God, we can never take that back. We really never want to be in the shoes of the borrower." In this case, we are not afraid to take any asset back given its size, location and the path of growth, especially where we're lending into, in the South and the Southeast and Texas, Arizona, places like that, which will still have growth. And there's housing shortages in those states. So from an asset perspective, we're a different company. We're internally managed. There are only a handful of mortgage REITs that are internally managed. We think that's a huge value proposition for investors because it gives the company liquidity. We are internally managed, and we have a very independent Board of Directors. And that independent Board of Directors wrestled the management contract from formerly Colony Capital away from them to be free and be internally managed. So there's a huge value proposition embedded in that. Secondly -- thirdly, our stock price. Our stock price is now at around $9 a share. The book value is at, call it, $12.50. And we pride ourselves on transparency. So when you go through some of these mortgage REITs and have big assets, you really don't know exactly what they own. You see a list of assets. You don't really -- when we think there's something that we talk about during a quarter, and it's an asset that we've discussed thoroughly enough, we put a narrative on that asset in the MD&A. So you know what we know. So take out a pen and take out an envelope and start hacking away if you'd like. What we disclosed, and I'm not suggesting anything we disclose necessarily means that there's an issue with the asset, we've had many assets that we've done narratives on that we wave goodbye to at par, right? But we just talked about it and we want you to know about it. So full transparency, internally managed, trading at $9 versus book value $12.50 at a very solid dividend yield with a potential for the dividend to increase. And in terms of the -- in terms of going back -- backward in stock price, we're buying stock. I bought stock, the company is buying stock. So we're saying this is a floor. Can the stock go lower? The market can do anything. We've seen -- we've all seen what happened in great financial crisis and how things -- and COVID and what that did to equity markets. But at this point, we're saying we believe in the stock we're buying it as a company and as a management team. And so we think it's really kind of like a bond with a high coupon and with potential price appreciation in it that is at least 20%, 25% from here.

And dividend appreciation.

And dividend appreciation. So we think the value proposition for the stock from a risk perspective, governance perspective, internally managed, new management team, disclosure, price, we think that this is a good value proposition.

I was going to throw in a plug for the fact...

It's hard to say that when you're trading -- it's hard for somebody to say that when they're trading at 120 book. I'd love to be trading at 120 book. But right now, on a relative value basis, we're cheap.

I was going to throw in a plug for the fact that they're internally managed at the top of the meeting, but I think that was a lot better than I can do. Are there any questions? Yes, go ahead.

Can you speak to what your edge is in terms of own acquisition? What do you do that makes [indiscernible]?

That's a great question because it is a very commoditized market. We spend a tremendous amount of time upfront before we quote alone. And Andy could talk more thoroughly about the process if you'd like. But by the time we quote a loan, all brokers know we're done. We're pretty much there. Unless something comes back in diligence, that's the borrower's fault. I cannot tell you in my 35 years of experience at major institutions, including banks, that there are plenty of originators who like to put out one pagers and tell you, "We'll do that, we'll do this, we'll do that," and throw spaghetti against the wall, then the process starts and like, "Oh, we didn't know that. We didn't see that. We have to change." If you have acquisition financing that you're providing, borrowers don't like to see the loan change when they're lining up their capital. Brokers have come back to us repeatedly to tell us that they blasted in their networks that BrightSpire closes on its terms. By the time we get to investment committee, we're sleeping. Because we've done so much work upfront on quoting that loan, by the time we get to investment committee and investment committee is the same 45-minute, 50-page book on every asset, whether it's $10 million or $50 million, by the time we get to investment committee, that loan is exactly the way we quoted it or we know there's a problem already. So that is a huge advantage in the marketplace. I can't tell you how many originators out there do not invest the time to spend on the loans upfront and just put one-page term sheets out there. And if the borrower comes back and they're in the hunt, they worry about it later. We don't do that. And we've really established a brand with some of the largest national brokers in the country that, that's how we do business and that's really been a huge help. We get a lot -- Andy could speak about the repeat business that we've gotten from borrowers.

Yes. I mean Mike really covered it. 70-plus percent of our business that we've done coming out of COVID has been acquisition financing. And so it's really important for our borrowers to know we're going to be there at the closing table. And so we've built a process that allows us to be there as we indicated at the onset. So that's been terrific for us, repeat business, both at the borrower sponsor level and then obviously with the various mortgage bankers and brokerage communities. So a lot of our business is repeat at this point.

Well, that's all the time we have. I want to thank this great team.

Thank you.

Thank you.

Thank you.

Have a great conference.