Claros Mortgage Trust, Inc. (CMTG) Earnings Call Transcript & Summary

Welcome to the 9:55 session of Citi's 2023 Global Property CEO Conference. I'm Arren Cyganovich with Citi Research. And we're pleased to have with us Claros Mortgage Trust CEO, Richard Mack. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or on the webcast, you can log into LiveQA.com and enter code gpc23 to submit any questions if you don't want to raise your hand. So Richard, we'll turn it over to you and you can introduce yourself and your company and provide any opening remarks before we go into Q&A.

Okay. Hi, I'm Richard Mack, CEO of Claros Mortgage Trust. Claros Mortgage Trust is an externally advised mortgage REIT. It's advised by Mack Real Estate Group. Mack Real Estate Group is a owner, operator, developer and property manager with assets across the country. Claros distinguishes itself as an investor by looking to take execution risks that we think we are uniquely positioned to evaluate and take on. And we think that allows us to get paid incremental return while using less leverage than most other mortgage rates. And I'm very happy to be here. Hopefully that's a brief synopsis of who we are.

It's great. So we'll start off with the same question we ask everybody. What are the top 3 reasons an investor should buy your stock today?

Price, price and price. So, yes, I mean I've said a little bit of this in my opening remarks. But we're going to go through a difficult period of time. We think being low-levered is going to really allow us to have a lot of flexibility to work through problems. Everyone's going to have problems. Additionally, we think that having very low office exposure is really key here. And the office exposure that we do have is what we would call noncommodity. That is by design. And we think noncommodity after class AAA is really going to be what outperforms and what people want going through the next few years. We have no Europe, unclear how deep a recession Europe is going to have or whether or not Europe is going to deal with any of its problems. And so, maybe there's not much of a dip in Europe, but I think Europe could have some complexity. And we've got this unique model that will allow us to kind of work through problems. Our borrowers understand that we have the capacity to take back assets. It's not what we want to do. But generally brings them to the table to put up more capital and to work a little bit more aggressively as opposed to thinking that we're not prepared to take strong action. So I think those are the main themes that are going to position us well outside of price and allow us to accrete book value up over time for our investors.

Thanks. And the other question we have that we are asking every management is, what is your number one ESG priority in 2023?

Well, that's different than the question that you showed me but I'll do my best in answering it. I don't think that we have a #1 priority. But we are really doing our best to think about ESG in everything we do. When we are making a loan, we're evaluating what are the environmental problems that could come up where this property is located and what is the environment going to do to the economy in that overall market. So I think as a lender, you have to be looking at the environment at all times. I think governance is part of everything that we do, and we have a diverse board. And we believe in transparency in everything that we do. And I think governance is not new, but it's important to just, to be focused on it. And social is a big part of our business, kind of we think about -- we are involved with [ Project Destin ], for example, trying to bring in more minority candidates into the real estate business. And Mack Real Estate Group has a big commitment to volunteerism and to matching donations. I can go on and on about this. So let's maybe just keep going. Hopefully that was a strong-enough answer.

Thanks. So we'll move on to, you touched on this a little bit, but how would you describe the current CRE lending environment today, and how has that evolved kind of prepandemic and postpandemic?

Yes, so look, unlevered returns are at probably the best on a risk-adjusted basis that I've kind of ever seen. I think it's a really interesting time to put out capital. You can get close to 10% unlevered returns. And it's extremely interesting in the transitional lending space. But at the same point in time, higher interest rates, which are great for our business, make it more difficult for some of our borrowers to pay. And so you've got to presume as an equity investor and how we look at the equity, the business from the equity side of Mack Real Estate Group is that you've got to be able to look through to a world where rates are going to -- where rents are going to catch up to rates and where rates normalize. And in that environment, asset values coming through an inflationary period should be much stronger. But it's a very complicated market to navigate because of where -- because interest rates have moved so quickly and have moved, as a general statement, faster than rates. And the last thing is banks are far less aggressive and are really, really discerning about who they'll provide capital to. And as a mortgage REIT, you need participation from the banks in your business. And that's getting harder for a lot of mortgage REITs, fortunately not us, to get access to. So it's, it's a pretty interesting time to see rates move so quickly.

What are some of the asset property types that you currently favor in maybe some of the ones that you might be avoiding currently?

Yes, so very boring answer, I'm sure. And what we've been doing for a long time now is our biggest sector is multifamily, we continue to have a focus on that. We like to lend on industrial, although until recently it's been quite hard to do so because there's been so much competition for even transitional industrial lending. And hotel has really been a standout for us. We've increased our exposure to hotel during COVID and post-COVID and really making a little bit of a bet that not only would asset values hold up but that cash flow would come back as people decided to travel more. And that's been the case. And so we're going to continue to focus on those 3 areas. And that's really allowed us to diversify geographically, which was not the question though into some of the higher growth markets where those asset classes, where there's more borrower demand for capital.

That was my next question.

Sorry.

The geographic exposures. But that's…

Yes. So on geographic exposure, we've had a view that as a transitional lender, you want to be where the growth is, that's where the developers need capital. And so it was a natural thing for us, to diversify out of the larger markets. And I don't think that trend of high growth in the sunbelt areas is going away. And so we're going to be continue to focus there. I think it was interesting is that our equity business has been focused there in those markets pre-COVID and being able to kind of follow the trends of our equity business for the debt business has been helpful.

And loans spreads are wider today. Where are you seeing them I guess relative to prepandemic and also relative to where your portfolio stays or stands today?

Yes, so I would say that lending spreads are probably 100 to 150 basis points wider, but the base rate has moved 500 points or 450 points. And so that's really why the unlevered returns are so strong. Our ROEs are pretty consistent. They're a little bit higher than kind of before COVID. So maybe they're up from 13% to 15% or 16%. But we're not stretching to take risk to make 20% returns here. We'd rather put out a little less money and keep our ROEs pretty consistent. That's kind of the approach that we're taking.

The nontraded REIT sector really had a big boom over the past couple of years. And we're seeing some retrenchment there. Is that impacting your business in any notable way?

It's not yet, but it may have an impact. I think just it's important to quantify that the nontraded REIT sector is about $1.5 trillion out of about $21 trillion overall commercial real estate market. So when you look at that, if they were to sell everything, I think there would be a big push down in values. And on the way up is the new sector. It definitely pushed asset values up. But I think there would've to be a major, major sell-off in the non-traded REIT to have a big impact in the market. But I do think some selling from the nontraded REITs will end up in borrowers' hands that have a value-add business plan. And hopefully that creates lending opportunities for us. Certainly valuations are down. And there are redemptions and nontraded REITs will sell. But I just don't think it's going to have a huge impact on the market because I just don't -- I don't see them liquidating on a wholesale basis. And bringing down the gate certainly is evidence of that.

The commercial mortgage REITs as a whole are benefiting from the rising rates that you had talked about. But maybe you can talk a little bit about how you've benefited from that from an earnings perspective? And then what actions could you potentially take to limit some of the impact whenever rates start to go back down, which doesn't seem very likely any so currently?

Yes. Look, I mentioned this a little bit earlier, the higher rates are great for earnings until borrowers can't pay you. And so it's really a double-edged sword. I think what the best thing that could happen for mortgage REITs is for everyone to see a path for when rates are going to come down. And then we could really feel good about the benefit that higher rates are having to our earnings because you could see that there was a ceiling, so to speak, to cap rates. And so, I think we have to be excited about our earnings increases based on higher rates, but we have to hold liquidity to be concerned about where values are going and borrower behavior. It's kind of giving with one hand and taking away with the other because you have to be ready for things to get more difficult.

That actually feeds well into, we got an investor question online, "Where, if anywhere, are you seeing early credit distress? And are we past the early stages in that?"

I think of course we're seeing it in office, but everything is pretty quiet. And I'm very concerned that office is going to become a very big problem in the capital markets and that, that could create larger contagion, if you will, that may have a difficulty -- may create difficulties for the entire real estate capital market. We also have a lot of liquidity on the sidelines. And so kind of what's interesting is that when nonoffice notes that are kind of nonperforming or slightly nonperforming go up for sale, there's a lot of interest in it. There's just a lot of capital looking to come in and take advantage of what may or may not be distressed. And it's happening faster than I would have thought. I would have thought people would have waited longer to see where the bottom is. It's a pretty interesting dynamic. Not a lot of distresses being raised. People are finding capital to carry their assets if they can see through towards an inflationary environment where assets are worth more. But certainly an office market where banks are selling loans at big discounts or needing to take capital reserves, large capital reserves could infect the entire market, and we could see a much bigger debt downturn than maybe we're all expecting at this moment.

Your CRE loan portfolio closed the end of last year at $7.4 billion, I think it grew about $1 billion from the prior year. What are you thinking about in terms of potential for loan growth and originations this year?

So I think it's really a question of how much liquidity we need to maintain, and we're trying to be really careful about that, and how many repayments we get. We're handicapping little to no repayments. But we expect that it's going to be better than that, right? That it's not going to be as much as we'd like, but that given our average loan size of over $100 million, we generally have very well-heeled borrowers and they'll find a way to refinance us. And that ought to give us a good amount of dry powder to do new lending at quite accretive rates. But we're trying to be really careful and prudent about how we think about liquidity. And we're going to try to use the capital that's coming from repayments as the source of new lending. And by the way, spreads haven't moved that much. And so the base rate has really helped us. And so holding on to the loans that we have is really not a bad situation either. So I think it's really going to depend on repayments and what the market gives us.

Okay. You have a bit higher unfunded commitments versus some of the peers that we follow. Maybe you could just talk about what that is. Is it heavier transition? Is it construction? What are the aspects that are…

It's primarily construction loans. And if you've got a big-enough balance sheet, we think construction is a really interesting place to play if you've also got the expertise. And I think we have both of those, and we try to balance it out. What we don't like about construction is money doesn't go out the door day 1. And so you've got to manage your liquidity around the construction opportunities that you do. However, when you do construction on these larger projects and you have the capacity to not only underwrite the developers' plans, but the general contractor, the subcontractor, the architects and the engineers and to step in if there's a problem, you've got a really strong balance sheet as your completion guarantor. What that means is that you're going to get the best building in a market. And we kind of like the risk dynamics around having the best buildings in markets with very strong sponsors. Those buildings are going to outperform. And so that's kind of what we like about construction. We have not had to take over a construction project midstream yet, but we're prepared to do so if we needed to. But these completion guarantees and these completion guarantors are pretty darn strong. And so we like our exposure and we like that alpha that it gives to our portfolio. And I think we've made one office construction loan and everything else has been multi or industrial. So I think we feel pretty good about our construction portfolio.

How is the competitive dynamics there? I'd imagine that construction lending is probably…

Yes, it's better.

All right. If there less people that want to do it? And that's kind of why we generate pretty high returns doing it. And it's a nice source of alpha for us. In terms of the optimal size for you to manage your overall lending portfolio, is there a size you expect to get to over time? Or do you feel like this is a good place where you are now?

Well, I think our first obligation is to manage our existing business to get our shares up above book value. And then I think if we can do that, we can think about growth. We want to be lower-levered than our peers. And so that's going to limit how much we want to expand our balance sheet. And query if now is a good time to expand one's balance sheet, yes, it's pretty interesting to put capital out. But I think you need to be conservative and careful around what could happen in the capital markets. So I think we just are going to focus on shareholder value. And if we do our job around shareholder value and we've got some creative ideas that hopefully will continue to create value, that will allow us to expand. I think we're at a sufficient scale, but I think more scale could be beneficial to the platform over time.

Got it. You had touched on office a bit already. Obviously that's a big focus for investors these days. Maybe you could just talk a little bit about some of the office exposure you have there and how well-reserved you are for potential losses down the road?

Yes. I mean, as a general statement, our office is noncommodity. And so we think that, that will help us if we need to take assets back. But our goal is not to take the assets back and work with our borrowers. The office dynamic is such that things are going to get worse before they get better. There are certainly trends in Europe and Asia that people are coming back to the office, but in the U.S. they're just not. So we're just going to be really careful around it, and we'll be flexible with our borrowers. But office assets are actually, as a general statement, it can be easier to manage than anything else. Multifamily is much more difficult. It's important to state. We've owned a lot of office in our careers in terms of the staff at Mack Real Estate Group. And we made a conscious decision because we'd own so much office in our past careers, to have 0 office on the equity side of our business and to have a very limited amount of office in our loan portfolio. And that wasn't because we saw work-from-home coming. It was because we don't like the cash flow dynamics around office. We didn't like it before, and we don't like it now. And so we've had just a very cautious view of office. And I think that's not going to change.

Well, I guess you just said it was not going to change, but what are some of the things that you would like to see in office before you would step back into the asset class?

Well, I think that you have to get -- if you want to step back with the asset class, you have to have a really unique asset or something that you think can be turned into a unique asset. And you have to get paid proportionate for the risk. So I think if you -- I don't see us doing this, but I think you have to really think at about 50% of cost at SOFR plus 600 or so, which is maybe where office loans are going to, if that's something you're willing to do. And I do think there could be instances where we might look at something like that. But it's going to be we're going to have to be really cautious to do that. I don't think that the market is going to reward us for putting on any office exposure even at those type of lending spreads. But I think that's probably what it takes to do it.

Got it. We have seen some headlines recently of some stress in multifamily in various places. The rents are starting to come back down a little bit and there's some concern about new supply. Why do you feel like multifamily should hold up better than folks think?

So to the extent we're seeing distress, it's because that we're seeing people who are not well-capitalized or over-levered. As a general statement, the markets are quite strong. What you are continuing to see, which is burning off, is the mark-to-market in the rent rolls. That's going to burn off, and you'll see NOI growth flatten I think pretty substantially because it's unsustainable to have 10-plus percent rent growth per year. And we have in a lot of markets, a good amount of new supply. So I think that the fundamentals are pretty good. But you can't sustain the type of fundamentals that we've had in multi. And so a flat-lining of rents for a little bit is a normal course event. If we have a recession, we could see some weaker fundamentals. On the other side, if you look long term, what you've seen is that multifamily starts have dropped precipitously. It's very expensive to borrow to build multi. And so I think long term, that will be very -- and inflation is increasing the cost to build multi. So I think long term, multifamily is -- has very good prospects. I think midterm, like every other asset class, there's going to be some distress around capital stacks.

Okay. You talked a little bit about some of the actions you could potentially take into restructuring or in a default situation. Maybe you can discuss how you're handling any kind of stress within the portfolio or how you expect to handle that.

Sure. You've got to treat each situation as a unique exercise. And so as a general statement, our borrowers are putting in more capital when they need to or buying a new cap if they need to, which is expensive because our caps were written well inside of where SOFR is today. And so there's a general statement, our borrowers are doing what they're supposed to do. But borrowers will call you up and ask for relief and try to get you to help them even if they're well in the money. And then there are some borrowers who may -- you may think that they are more out of the money who don't bother and just kind of get on with it and do what they're supposed to do based on the loan documents. So we're going to have -- it's going to be hand-to-hand combat for everybody. We're going to be -- everyone is going to be talking to their borrowers. And we believe in proactive asset management, which is, I think, another differentiator for us. We want to be ahead of the borrower. So we want to -- if we think there's going to be a problem, we're going to pick up the phone and call them first before they call us. So this is going to be -- every transaction is going to have some type of a negotiation. And you really -- you want to work with your borrower to give them the best possible outcome while protecting the interest of shareholders. And if that means that you have to say, look, we cannot give you more accommodation than this, and if you want, we'll take the keys, of course we're willing to do that. But you have to be willing to say that so that you can be as flexible with your borrowers as possible and as we want to be. And so we're all about providing flexible solutions to our borrowers. That's what they came to us in the first place, and we're not going to change now.

It seems to me that there's more challenges from just the liquidity of probably office specifically than the actual fundamentals deteriorating. So most of the challenges or issues we've seen are from loans that are coming due near-term. How do you feel about doing extensions for those borrowers given that right now just the environment for liquidity is just so poor?

Yes. Look, extensions are definitely part of our toolbox. And most of the time, to do an extension, we're going to look for the borrower to put some capital in to really show us they're committed. But look, they're -- under the right circumstance, we might do an extension without it. I mean we're going to be flexible and we're going to evaluate every circumstance. We also have borrowers that has right extensions. And so every loan is bespoke. I would say, very, very few, don't have some type of a coverage requirement or a debt yield requirement that they may or may not be meeting. And so that gives us a lot of power. But at the same point in time, given the lack of liquidity in the market, we do want to be flexible where we can be. But we can't be too flexible because we want the cash because it's a great time to put it out. So it's a balance on whether you grant extensions and what you require to grant them.

Okay. Let's switch gears to the right side of the balance sheet. Funding costs are rising along with the loan yields. What are some of the more attractive forms of funding that you're finding today to fund your new loan originations?

Yes. So I think there are lot of opportunities in the market. We are tending to stick with our knitting, so to speak, which is we are a floating rate lender, we're a floating-rate borrower. We borrow a lot less on our A-notes and warehouse lines than we could. We try to give ourselves some cushion. So while it may be imperfect, we do like and have great relationships with our bank warehouse lenders. We're going to continue to use them. We're going to continue to use A-notes. And we're going to evaluate the capital markets. If we see an opportunity in the capital markets to issue longer-term unsecured debt, we'll certainly do so. But again, we're not anxious to balloon the balance sheet at a time when capital is costly. So I think we'll wait and see if capital costs come in to the point where we want to do something more than kind of just sticking to our business as usual.

Got it. Maybe just in terms of the leverage, are you seeing banks get a little bit tighter in terms of what they will advance on loans these days? And what kind of leverage do you expect to be able to generate going forward?

Look, it's a real question of where V is, C is down, but where is V. So I think it's very, very hard to answer that question. We are lending less, and so the banks as a percentage of advance are pretty much at the same spot, but their attachment-to-attachment point is lower. And that's kind of the way we are kind of perceiving our credit counterparties.

Okay. Nonmark-to-market funding has been an increasing focus among commercial mortgage REITs after the freezing of the markets in the pandemic. What proportion of your funding is nonmark-to-market?

I'd say about 80% is nonmark-to-market. However, if you have an underlying default, then there are mark-to-market consequences. So it's a question of whether or not you consider underlying default to be a mark-to-market, which we don't. But some people might.

Yes, I think that's essentially how most people view it. You have nonmark-to-market on a capital spread widening, et cetera, but if you have a credit issue. Have you had banks push you in terms of any business…

We haven't had any margin calls. And part of that is because I think we're trying to be proactive. So if we see a problem, we'll go to the bank and say, hey, we're going to pay you down or we want to move this out of one facility and put it into another. So we are -- I think we're going to continue to be proactive, and I think that's why the banks want to continue to do business with us.

Great. All right. Well, we'll close out on this one. What's one area that you think investors are under-appreciating your story and your strategy that you'd like to highlight?

Yes. I would kind of go back to where we started, which is lower leverage and small office exposure and the ability in a difficult market because of those 2 factors, and our execution capability of the broader platform, to -- I think, to outperform. And that's I think the key as we wake up every day, that's what we're thinking about, how do we take advantage of the place that we're in right now and really use our execution capabilities to make sure that we get the best outcomes for our investors.

Great. All right. We'll stop there. Thank you very much for attending our conference. Appreciate it.

Thank you.