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

Hi. Welcome to Citi's 2024 Global Property CEO Conference. I am Arren Cyganovich with Citi Research. Pleased to have with us Claros Mortgage Trust and CEO, Richard Mack. This session is for clients -- 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 of you in the room or on the webcast, you can go to liveqa.com, and enter code GPC24 to submit any questions if you don't want to raise your hand.

So I will turn it over to you, Richard, the first question we always ask everyone is, what are the top 3 reasons an investor should buy your stock today?

Okay. Well, I may go over the top 3 to maybe include 5, but I'll do the best in answering the question. Look, we're trading at a big discount to book value. We're paying a dividend. So I think there's an opportunity for people to get wait -- paid to wait. But that's really what you could say about the sector generally. I think what differentiates us is, number one, we are a real estate owner operator developers. We've been through this before. We know how to manage our borrowers' problems, help work through those issues and understand how to support our borrowers and when not to support our borrowers. We are low leverage. We have a low office concentration, and we provide what I believe is a high level of disclosure. And I think we sometimes are penalized or have been in the past for having a lot of construction loans, particularly in multifamily. And those are really performing well. I think one of the big reasons they're performing well is because we have strong borrowers, they are the best assets in their markets. And let's not forget, they generally have completion guarantees, which include interest coverage guarantees. And so those are just some reasons that differentiate us and I think make us different. Just a little bit on kind of background. Claros Mortgage Trust is part of a larger company called Mack Real Estate Group. We have about 250 people across the country, development offices on the West Coast, in the Southwest and the Southeast and are based in New York. We are an owner operator manager and property manager and developer of assets. And so we have the skills that our borrowers do. And I think that gives us the advantage to the ability to understand their business plans in a differentiated way.

Thanks. Maybe you could start off with describing how is the lending environment today and how that -- how does that compare versus, say, a year ago?

Yes. So I want to start by saying that as compared to 2 years ago, things are very, very different, right, elevated base rates and elevated spreads. But as compared to last year, we are starting to see some differentiation. Spreads are actually coming in as you would expect when rates have moved up so much. But really it's the best projects. The best projects are starting to see a lot of bids for them and spreads coming in a bit. And the more difficult projects really are having a hard time getting capitalized. So we're starting to see differentiation. We're starting to see capital come in. We have a lot of inquiries to sell loans. We've sold loans at par and close to par. And we're seeing new entrants come into the market, providing liquidity. So we're starting to see some green shoots even in the face of a rate environment that is tremendously uncertain.

The industry has seen negative credit migration over the past year. You haven't been immune to that. I think at the year-end, you had about 26% of the portfolio on what we would refer to as a watch list rated 4 or 5 on your internal rating scale. Are there any themes that led to some of these challenges and what reserve actions have you taken to help prepare for potential losses?

Sure. So I think we are fast to move assets to higher-risk category. But that does not mean that they're not going to pay off and/or pay off in full. We just had a, last week, I believe, a 4-rated asset pay off in full. So we tend to move things as a result, certainly of events that we can't forecast and we want to be careful about. So an impending maturity where someone may not make the as-of-right extension may be a reason to move it to a 4, but it doesn't mean that there's going to be a loss. So we kind of -- we're really trying to look at this as a way to give transparency to our portfolio that doesn't always reflect that there's a problem. One of the big things is that we have always had run with a high level of risk rated loans. And if you look going back historically, it's been between 10% and 25% with some variability in there all along. And that's been because we've usually taken the view that when there is some type of default, even if that default was a small default that's going to create more leverage for us relative to the borrower. That's a reason enough to move the risk rating. And so the risk ratings for us are important, but they don't tell the whole story and looking at how our history has been with higher risk rating, I think, tells maybe the better story about how we think about risk rating going forward.

And maybe just on the reserving, have you reserved for your risk rated 5 loans? Do you have specific reserves against this?

Yes. So we think that we're reserving for 5-rated loans properly. And certainly, there are some 4-rated loans that we've taken reserves on, but we moved some from 3 to 4, where we had already taken the reserves and moving it from 3 to 4 didn't create a reason for us to increase our reserves on them. So we're trying to get ahead on taking reserves, whether it's related to where the loans are rated or not, I mean just thinking about what the probability-weighted outcomes are.

And maybe you could talk about some of the options that you have whenever you're looking at a loan, and you're thinking about some sort of restructuring if it does reach that default stage?

Yes. So we think that we're kind of really well positioned that we kind of -- I think your question is kind of, to me when we were talking about this was what's in our toolkit. And we kind of think we have basically every tool available in the toolkit, right? We start with the premise of if we have a borrower who is executing and putting capital into a sub-performing asset, they're doing both of those. We're going to work with them. Sometimes if they're doing one of them, we're going to work with them. But if they're doing neither, we're going to take very drastic action. Thus far, we've taken back 2 assets, REO. I think both of those were the right things to do. You look at our hotel portfolio, which is the one that's a little bit mature on our books, cash flow is back up to above 2019 levels. And if we were in a normalized capital market, we probably have not only a profit above where we could have sold that loan when we took it back, but maybe even a profit above our par basis. But we're going to be patient in thinking about when we sell it because it's cash flowing, it's got fixed rate financing on it. And so we don't feel like there's a rush. The second asset that we took back, it's really too soon for me to kind of start talking about metrics. But we've seen a lot of low hanging fruit in that asset. And again, both of those were situations where not only was the borrower not executing well, they weren't protecting with capital. So I think we really start with our framework. We don't want to extend and pretend. And that is going to be thematically how we've operated and how we are going to try to operate going forward.

And we've seen in the industry some credit issues popping up within multifamily. I think multifamily is about 41% of your portfolio. I personally feel like the fundamentals are pretty solid in multifamily generally. What are your views on multifamily in your portfolio and for future investments?

Yes. So a lot of our multifamily are in the high-growth markets. And so those are the markets that are struggling the most. And we think that there -- and there are also some of the gateway cities that have not recovered. So those are the places where there are problems. As it relates to the oversupply issue, new supply has kind of dropped off a cliff. And so it's going to get absorbed, but it's going to be a little bit painful with kind of negative rent growth in some of these high-growth markets for a while. But our overall view is that we're undersupplied in housing in this country. And so we are very constructive long term on multifamily. But valuations are unquestionably down. However, I think what's kind of interesting is there are very few trades. And the trades that we are seeing are still generally happening with negative leverage. And so how much longer that is sustainable? I don't know, but kind of multifamily assets that are trading are trading relatively well, but we haven't really seen a big push to liquidate yet. So we're constructive on multifamily long term, but I think we have to note that there are headwinds at this moment in some of the gateway cities and the high-growth markets.

I'd say last year, investment activity for the Group has been relatively muted. Folks are dealing with problem assets, deleveraging. And most of the investments have been to prior commitments. What do you need to see to make you more confident you'll be able to start to grow the portfolio?

Well, I think it's probably the whole market, but it's probably looking at it this way. But as it relates to us, specifically, we are kind of on hold trying to understand where and when market stability is going to happen. And market stability is really going to be driven around clarity as to where the forward yield curve is going to sit and where short-term rates are going. Until there's kind of clarity around that, meaning either that we are going to be at 5% for 3 more years and kind of we're in a world of distress and kind of you've got to rethink everything in your portfolio, or we see real clear indicators that there are going to be rate cuts. I think we need to wait to see that stability. That stability in turn, I think, will be an indication to a lot of capital still on the sideline that now is the time to buy because discounts may retreat as the world comes back. And so that -- we're waiting for that indication to start thinking about things other than managing our liquidity. And so right now, we're thinking about liquidity, and we're not focused on growth and opportunity. But long term, I think that once there is stability, alternative lenders are going to play a much bigger role in the market than they ever had before. The movement away from regional banks and the regional banks lending in real estate and the money center banks having an increased cost of capital is going to make nonbank lenders a more essential part of this market than ever. And so if you can look forward to the point of stability, it actually gets a little bit exciting.

And maybe it was on your last earnings call, I think you talked about you might see some slow rebuilding of confidence in the real estate market, and it may take until 2025 to see fully embrace refinancings and recapitalizations. Can you expand on your thoughts there why do you think it will take a bit longer?

Yes. I mean it really follows on my previous comment. We need more confidence in the market for transaction volumes to happen because the market is kind of locked up. And there have been commentary from distressed investors that if you wait for there to be clarity around rates, it's going to be too late. As a lender, we do not need to be first to this [ dance ], but we're going to need to see people stepping in and they're being confidence in the market for transaction volume to pick up. And kind of until that happens, it's just hard to see any reason for people to transact. And right now, a lot of what the market is doing is saying, we want to pay for option value until we have more clarity. And so we see that happening everywhere in the market. Everyone is doing it. That's the game. We try to make sure that our borrowers are paying as much as they possibly can for that extension option, and we're not granting it for free.

Maybe you could talk a little bit about what kind of property types would you favor financing today? And are there any that you're specifically avoiding?

Yes. So, we try to think about that every day. We were purposeful in having a very small office concentration. I don't think that we understood the full extent of the difficulty that office would have. But our perspective was that you've got to be really careful with any asset class that trades on NOI and not cash flow. And so we've just had a negative bias to office. We had a negative bias to retail. We have zero stand-alone retail. We're more constructive on that today than we have been in the past. And if you think that we're headed towards a recession, you certainly have to be really careful about hospitality. But I think when we look at our portfolio concentration and construction, I think we're pretty comfortable with it. We might be opportunistic around office, but it's going to be always going to be our smallest asset class. And I do think we want to try and do some stand-alone retail in the future because we believe that, that market has stabilized. The reason we didn't lend on retail historically was, and the reason we don't have very much office is because on the bad retail, you can't get paid enough to lend on it. And on the good retail, you couldn't get paid enough to lend on it, right? So in fact, the bad retail, there was no price they could pay you to lend on it because of the absolute binary outcome surrounding a lot of retail. So I think we're kind of allocated properly, but we'll be opportunistic as new information arises on each asset class. And this is a market where every geographic location is different as to how different subsets of asset classes is performing. And every market is different as to how their economies are performing. And so it's really about the micro in each market in which you operate with kind of an allocation perspective at the portfolio level thinking about the macro.

That was going to be the next part of the question was, are there any geographies that you see within the U.S. that are more attractive? But I guess you're basically saying it kind of depends on property in those [ generally ]?

I think that's right. There are a few themes that are really interesting right now as real estate investors, and one of those is the impact of onshoring and near-shoring. I think people are underestimating the impact that's going to have in terms of job creation and net population migration in the U.S. And we are starting to track that on the equity side of our business. And we think thematically being able to lend in that area will be interesting over time. But generally, it's just -- it is market and asset class specific.

And maybe you could talk about what kind of new loan spreads you're seeing in the market today? Where were they pre-pandemic? And how does that compare to what you have in the portfolio?

Yes. So spreads kind of pre-pandemic were, call it, [ 350 to 450 ] over those moved since rates backed up, probably 100 basis points. And for the best assets have probably come back in about 50 basis points, reflecting on the fact that good assets, there seems to be competition for and bad assets are really having a hard time finding anyone to lend on.

The industry's earnings, I guess, are benefiting from the higher base rates that we have right now. How are you positioned whenever rates start to come down on the Fed pivots, so you start to see some of your base rates fall?

Yes. I think it's one of these situations where as the real estate market generally feels like good news can be bad news, right? So as base rates come down, the value of our book and I think a discount to book value should decrease, but also more loans will get paid off and come off nonaccrual. So the impact to earnings is modest, but it does exist. But the value creation in book value and the benefit of getting loans off of nonaccrual will more than offset any reduction in base rate that you're getting. Plus I should add, we generally have floors in these loans. Of course, we've flown way through these floors. And so those floors do give a level of stability. And so getting back when rates were super low, movement up was very valuable. Now we want to try if we could get to a more normalized rate environment, not a super low and not a super high one, mid-3 type of rate. That has a really positive impact while keeping earnings pretty high on the overall book value. And so if you think that that's where rates are going, that's a pretty constructive place for floating rate lenders generally and for the industry.

Okay. Maybe from a funding perspective, we're seeing issuance improve in corporate debt and CMBS markets. What are you -- where are the most attractive forms of funding that you see today? And how would you be funding new originations?

Yes. So in the beginning of January, it looked like the real estate capital markets were going to really rally and CMBS was going to lead the way and CLO market would come back other than multifamily, which received some issuance, kind of all on the heels of that. And then we got some bad news and that like fell away. So my short answer is there's no great place to finance things today. However, what I do find interesting is that if you're willing to pay a little bit more, people will give you a big advance rate or pay what you were paying before, I should say. People will give you a big advance rate. And we have, because we are low levered, we have people saying, can we provide you financing on your unlevered assets? Can we give you more leverage? Which is both encouraging and strange to me in this environment. But I think what it's reflecting is that there's starting because transaction volume has been low. You're starting to see people say, I've raised this capital, I got to put it to work. So nothing is super attractive, but capital is available. I guess my view is, if you were originating today, the best thing to do is originate unlevered and wait for the capital markets to come in a little bit before you put leverage on it, because I think that you'll like the pricing better. And given how much risk there still is in the world, you might won't like to have unleveraged assets for a little while. And so I think you want to be patient about financing them in an environment where I think there's a lot of capital market instability out there.

So in terms of leverage expectations, would you expect to kind of continue to delever the portfolio, or would you...

Again, until you have a real indication that there's capital market recovery, I think that's -- it's prudent to delever. And with base rates where they are, I don't think you're getting paid that well to leverage them. And just because when you look at the relative accretion of leverage today because base rates are such a bigger part of the return, you don't -- you're not picking up as much on a relative spread basis. So in today's environment, there's a lot of reasons not to use as much leverage. And I think being low leverage provide us with a lot of flexibility such that if we really were confident we could expand our balance sheet and lean in. I think at this point in time, we don't have conviction and so we're trying to be prudent.

Okay. We do have a couple of investor questions. One was on a negative credit rating outlook. Are there any concerns on that aspect?

We're concerned about everything all the time every day, right? So like we come into work and we say who's paying us off now? And where is our next liquidity event coming from? We handicap them. Things don't happen on a quarterly basis the way you'd like to have them neatly in your earnings sector. And so our expectation is that if we continue to do our job, we resolve loans, we increase liquidity, the world comes back. Maybe we can change that rating. But our job is to go to work every day and try to work through problems and get paid off and get ready to go on offense again. And that's kind of and make sure that we have enough cash to keep everything going. So we try not to worry too much about the ratings. Although if you're asking me what I'm worried about is everything, every day.

Yes. The second question is kind of related. How do you think about liquidity over the next few quarters?

Yes. I mean we think about liquidity every day, right? We like having unlevered assets. We know where and how we can lever those if we needed to. We think that people keep approaching us to sell loans. When we get the prices that we like, we're a seller. I think we've been pretty successful at selling at or near par. And so we're just constantly saying, how do we manage earnings against liquidity every day? And that is kind of the environment that we're in, whereas there was a time when we were -- how do we manage having enough origination so that we're keeping earnings going? And so this is a business where managing your cash is dynamic in an environment where you're originating and an environment where people aren't paying you off as fast as you wanted to. So this is the same dynamic that we were managing previously when we were trying to put out cash rapidly in reverse. And so we're used to having to manage our cash. There -- this is art not science.

In the industry, I guess, over the past several years have increased the amount of non-mark-to-market funding. It's been kind of a focus for commercial mortgage REITs. What's your proportion of funding is non mark-to-market? And what's the risk that credit markets for struggling properties [Technical Difficulty] [ would cause ] a margin call?

Yes. So there's a lot of ways to look at this. The first thing to note is that even when you don't have -- when we have mark-to-market, these don't work like repo loans where they take your collateral, see you later. And we've never had a margin call, but more than 50% is subject to margin call until we've never had one. And we have fairly wide bands at which margins have to move before things can get called. So it's definitely a place that we think about and worry about. But we think we know how to manage our relationships there, and we haven't had -- given everything we've been through, we haven't had a negative result yet, but it's something to be worried about or concerned about, I should say.

And I forgot to ask this earlier, but what are you seeing from a competitive environment? Banks generally kind of pull back from the market?

Yes. So it's a have and have-not market. Our counterparties seem to want to extend us more credit, which is great. We're reluctant to take it. But I think the bigger people with more infrastructure who can demonstrate through different cycles that they can handle problems are going to continue to have access to capital and other people who haven't necessarily been able to do that are going to struggle.

Okay. We're wrapping up here. What's one area that you think investors are underappreciating about your company, your strategy that you'd like to highlight?

Yes. I mean, I think these one and these 3s are hard for me. So I think I'll just reiterate what I said at the front end, low leverage, low office, high degree of disclosure. But if I have to pick one thing, it's that we're real estate people. We've been through this. It's not fun, but you work through it, you get to the other side and you solve problems, and you don't ignore them. And I think that is when you're used to owning assets and you're not afraid to own assets. I think it gives you an advantage to not trying to extend and pretend and really dealing with issues.

All right. Well, thank you, Richard, for coming. We really appreciate having you.

Thank you. Thanks for the questions.