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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and thank you for joining the Lument Finance Trust Second Quarter 2023 Earnings Call. Today's call is being recorded and will be made available via webcast on the company's webcast.
I would now like to turn the call over to Andrew Zang with Investor Relations at Lument Investment Management.
Thank you, and good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust's Second Quarter 2023 Financial Results.
With me on the call today are James Flynn, CEO; James Briggs, CFO; James Henson, President; and Zachary Halpern, Senior Director of Portfolio Management.
Yesterday, on Tuesday, August 8, we filed our 10-Q with the SEC and issued a press release to provide details on our second quarter results. We also provided a supplemental earnings presentation, which can be found on our website.
Before handing the call over to Jim Flynn, I'd like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
When used in this conference call, words like outlook, evaluate, indicate, believes, will, anticipates, expects, intends and other similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Forms 8-K, 10-Q and 10-K, and in particular, the Risk Factors section of our Form 10-K. It is not possible to predict or identify all such risks. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements.
Furthermore, certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation nor as a substitute to the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures is the most -- to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. For the second quarter, we reported GAAP net income of $0.03 per share, while distributable earnings were $0.04 per share. In July, we paid a dividend of $0.06 per share with respect to the second quarter.
I will now turn the call over to Jim Flynn. Please go ahead.
Thank you, Andrew. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the second quarter of 2023. We appreciate you all joining us today.
I'll start with the market. With respect to the overall multifamily market during the first half of this year, we observed decrease in demand and a slight rise in vacancy rates, resulting in some modest rent growth of approximately 1% across the portfolio. It's important to note that that's the national trend and doesn't apply uniformly to all metro areas. Some cities we've seen flat or negative rent growth, some of the bigger gainers over the years, Vegas, San Francisco, Phoenix. Others, we've seen rent growth of right around a few percent of historic averages. You've seen that in Boston, San Diego, Knoxville cities like that. So there is certainly a -- as it typically need to pay attention to, all of the markets specifically.
Despite lingering economic uncertainty over the long term, we do remain optimistic that the multifamily sector will manage to navigate through these hurdles and continue to be a well-performing asset class in the commercial real estate. Multifamily economic backdrop remains constructive, positive job growth, elevated single-family prices and affordability in many locations across the country, and obviously favorable supply/demand demographics.
Our cautious outlook for the multifamily lending environment in the second half of 2023 remains unchanged. While investment sales activity remains depressed, we are seeing some stability in rent conditions and positive, albeit slowing, net operating income growth. We view these signs of increasing stability in asset valuations that we project will translate into greater activity over the remainder of 2023 and into 2024. We believe the credit profile of the middle market housing continues to be supported by favorable supply-demand dynamics, demographics and long-term rent growth trends, creating an attractive investment opportunity for LFT shareholders. With respect to the asset financing market, the CRE CLO securities market experienced significant limitations in Q2 as it has for quite some time. Access to the market and its attractive pricing and terms were largely unavailable. And as a result, we pivoted from looking at a public transaction to executing a private collateral financing transaction, which closed on July 12.
The collateralized CRE financing transaction was secured by approximately $386 million of first lien floating rate multifamily mortgage assets. In connection with this transaction, which shares similar match term nonrecourse non-mark-to-market features of the CRE CLO, approximately $270 million of investment-grade rated senior secured floating rate loan was provided by a private lender and approximately $47 million of investment-grade rated notes were issued and sold to an affiliate of LFT's manager.
The outstanding liabilities of this financing transaction have an initial weighted average spread of 314 basis points over 30-day terms SOFR, excluding fees and transaction costs. The initial collateral pool consisted of 25 first lien floating rate mortgage loans secured by 32 multifamily properties located across the United States. The weighted average spread of the initial collateral was approximately 365 basis points over 30-day terms SOFR. The majority of the collateral was acquired from an affiliate of the manager at an aggregate discount to par of approximately 1.5%, which we estimate works out to an effective spread on the initial collateral pool north of 425 basis points. All the mortgage assets were originated by an affiliate of our manager. This financing transaction provides for a 24-month reinvestment period that allows sensible proceeds from repayments of the mortgage assets being reinvested in qualifying replacement mortgage assets subject to certain conditions.
Despite disruptions in accessing the traditional CRE CLO market, we were able to successfully pivot and execute the private managed transaction structure that significantly increases our levered investment capacity at attractive economic terms. We are cognizant of the need to maintain a strong liquidity position as we potentially enter a challenging part of the market cycle, both to opportunistically deploy capital into new investments and to drive positive outcomes on underperforming assets in the portfolio. The company is well positioned to manage through the changing market conditions as all of our secured financing is match term and non-mark-to-market, including the collateralized transaction we closed subsequent to the end of this quarter. Further, the company does not have any corporate debt maturities until February of 2026.
With that, I'd like to turn the call over to Jim Briggs, who will provide details on our financial results. Jim?
Thank you, Jim, and good morning, everyone.
Last evening, we filed our quarterly report on Form 10-Q and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. Supplemental investor presentation has been uploaded to the webcast as well for your reference. On Pages 4 through 7 of the presentation, you will find key updates and an earnings summary for the quarter.
For the second quarter of 2023, we reported net income to common stockholders of approximately $1.4 million or $0.03 per share. There are a few items I'd like to highlight with regard to the Q2 P&L. Our Q2 net interest income was $7.5 million compared to $8.2 million in Q1 of '23. This decline occurred primarily because our investable capital was intentionally held a significant undeployed liquidity during the period in anticipation of the execution of a collateralized financing transaction, which we ultimately closed in July.
Our unrestricted cash balance throughout Q2 was in excess of $95 million. June 30 pro forma unrestricted cash, giving effect to our July 12 financing transaction was approximately $40 million. Increased earnings rates on our cash balances helped mitigate some of the impact of the cash drag. However, this was more than offset by the increase in incurred interest expense related to our CLO liabilities as SOFR rose 22 basis points during the quarter from 4.87% to 5.09%. Exit fee and other prepayment-related income was also down by approximately $400,000 sequentially.
Our total expenses were $4.4 million during Q2 versus $2.7 million in Q1. This quarter-over-quarter increase was driven primarily by $1.7 million or $0.03 per share of deal costs we incurred in pursuit of executing a CRE CLO securitization transaction that Jim mentioned us pivoting from. Given volatility in the capital markets and significant execution risk, we determined to terminate this transaction before it went to market and instead pursue the transaction closed in July. For Q2, we reported distributable earnings of approximately $1.9 million or $0.04 per share. The primary difference between reported and net income and distributable earnings, was the approximately $550,000 increase to CECL general reserves in the quarter, primarily due to changes in the macroeconomic forecast. As a noncash unrealized items, these charges are adjusted out for purposes of calculating distributable earnings. Excluding the previously mentioned $0.03 per share of costs expensed in Q2 relating to the abandoned public CRE CLO transaction, distributable earnings for Q2 would have been $0.07 per share.
As of June 30, the company's total book equity was approximately $239 million. Total common book value was approximately $179 million or $3.43 per share.
I will now turn the call over to James Henson, who will provide details on the company's investment activity during the quarter and portfolio performance.
Thank you, Jim Briggs, I will provide a brief summary of our portfolio activity during the second quarter.
During the second quarter, we experienced $72 million of loan payoffs which included the loan on our sole retail collateralized asset. This represents an increase relative to the $52 million of loan payoffs experienced during the first quarter. The $72 million of payoffs experienced during the second quarter represented a 28% annualized payoff rate. While this payoff rate is below our long-term historical average, we expect we will continue experiencing similar payoff speeds over the coming quarters due to persistent interest rate volatility and economic uncertainty.
During the period, we acquired approximately $73 million of loans from an affiliate of our manager. 75% of these acquisitions were collateralized by multifamily properties and the remaining 25% were collateralized by health care-related properties.
As of June 30, our portfolio consisted of 66 floating rate loans with an aggregate unpaid principal balance of approximately $1 billion. Approximately 89% of the portfolio was collateralized by multifamily properties located across the country. Approximately 74% of the portfolio was indexed to LIBOR as of June 30. On July 6, we successfully transitioned all of these loans to SOFR, and our portfolio is now 100% indexed to SOFR.
Our investment portfolio performed well during the second quarter. While we have experienced some modest risk migration from 3.2 -- an average 3.2 in the prior quarter to an average of 3.4 in this period, only 1 multifamily loan remains rated to 5. We have not recorded any specific allowance on this loan, which remains in monetary default and for which we are pursuing all available remedies. During the period, we had no additional loans in the portfolio rated as a 5.
As Jim Flynn described earlier, after the quarter end, we acquired an additional 25% -- 25 floating rate mortgage assets in connection with the execution of a $386 million collateralized financing transaction, which closed on July 12. All of these loans were collateralized by multifamily properties. Slide 17 in our supplement provides further detail relating to the 25 loans and the initial collateral pool for that financing. Slide 23 in the supplement provides a pro forma capital structure for the company, giving effect to the July 12 transaction. As discussed earlier on the call, we expect to continue to rely on the depth and breadth of our managers' active asset management capabilities to mitigate risk within our portfolio and to protect shareholder value.
With that, I will pass it back to Jim Flynn for some closing remarks.
Thank you, Mr. Hansen.
We look forward to updating everyone on our progress. We appreciate time and interest and happy to open the call up to questions.
[Operator Instructions] The first question comes from Crispin Love of Piper Sandler.
First one, just looking at the weighted average term -- remaining term of your portfolio about 15 months or so. Just given the macro and rate environment here in multifamily, I'm curious how you expect maturities to be handled for many of these loans that may mature over the next several quarters. Would you expect some extensions here, any infusions of cash? Or just otherwise, how would you expect maturities to be handled?
Thanks for the question. I think there's a little bit of a blend. We've actually seen across our broader platform some higher payoffs, frankly, than we might have expected a quarter ago or two. So we actually do expect a reasonable amount of payoffs coming here over the next couple of quarters as you pointed out.
We also expect to have some loans extend with paydowns and other terms changing on the lender's behalf to get those executions and it's going to be a mix. But we're -- in all of the borrowers that we've been speaking with, we've generally had constructive and positive conversations where we expect their plans to either move forward with a sale and which will get paid off or has plans to refinance at lower leverage. [indiscernible]
And Jim, I think you may have mentioned this in the prepared remarks, but I might have missed it. Quarter end, your cash balance was just under $99 million. The pro forma cash balance inclusive of LMF 2023-1, did you say that was $40 million in a similar balance? Excuse me, 40, 4-0?
$40 million, that's right, Crispin.
Perfect. That's what I thought. Okay. And then just if I could sneak one more in. How close were you to completing that abandoned CLO transaction? Can you just explain the kind of the key reasons of going with the private transaction pricing, anything else at play? And then just any detail on that $1.7 million, how that was -- what was spent?
So I would say we were very close. The reasons why we were not able to get that transaction done are SVB, Signature Bank, CS, but we were very close to getting -- launching a public deal or potentially even placing it in direct accounts when all of the banking noise and crisis kind of really blew up.
I mean we were ready to go. I mean it was days and weeks and -- but we did continue to explore. We had kind of -- we have been dual tracking, looking at different ways. We've talked in the past about looking at private transactions. So we had known the capital markets have been so volatile, and they opened and closed infrequently and for short periods that we had been anticipating a little bit of both.
At that time, we thought we had a window to get the trade done, our bankers as well slowed very quickly. And we continue to see if we would get another window, but the shoes get dropping there on the banking side and spreads, even if you could get one done, spreads too were -- we probably would not have been able to do a dynamic or reinvest -- have a reinvestment period. So things kind of moved against us pretty quickly. And we pivoted back to the private transaction and just kind of went full steam ahead to get that done right around that time. So unfortunately, we were close. Yes. It was, again, a static deal, I think, at the time, I would expect pricing maybe would have been a little bit better. But as soon as the market changed, it was either worse or not even achievable at all.
The next question comes from Stephen Laws of Raymond James.
Congratulations on the private deal in July. I know financing is something you guys have been looking at for a number of quarters now. So I know you were happy to see the deal executed. As I think about it and on your last point about it being a managed collateral pool, the reinvestment period is still open and your first CLO as well, obviously, through year-end. Can you talk about how accretive any turnover is? What are your typical spreads you're seeing on maturing loans that are paying off versus where that can be redeployed?
Yes. I think it's obviously a little bit better. We've had most of the loans paying off would have 3 handles on them, mid and high 3. I think new loans, I think that 4 to 4.50, 4.25 has kind of been where loans that are getting done or that are trading have been kind of in that range. So there'll be -- there should be a modest pickup. I would expect kind of lower leverage that we've seen in the market as well. But it's not -- there will be a modest pickup, but it's 25 to 50 basis points would be probably my guess, on average, depends on the size and scale.
Great. And then just I want to make sure we've still got just the one 5-rated loan that didn't change, but it looked like 4-rated loans dropped from 12 to 10. I think I'm guessing maybe one was the retail loan that I think you mentioned in your prepared remarks, but I may be wrong on that. So can you talk about what you're seeing in that 4 bucket? Any trends either geographic or you're mostly multi? So I need geographic trends? Is there any correlation response for concentration among those?
No, I'll obviously introduce Zach Halpern to give you guys some color on that. And just on -- Stephen, on the last question, I do want to -- as I said, the new transaction was equated to spreads of about 4.25 based on what we paid for them. So I was new transactions for our first CLO payoffs have been around $360 million in that pool as well as we paid off. So my point around reinvestment and the pickup in spread is for -- is really related to the first CLO, not the second.
Got it.
Yes, go ahead, Zach.
Yes. I was just going to jump in quickly on risk ratings. I don't think we're seeing any super negative geographic trends or anything super specific there. As you know, implicit in these risk ratings or explicit really is the debt service and interest rates and as SOFR is ticking up, or just seeing a little bit of downward migration in debt service coverage. And so I think that's really what you're seeing reflected here. It's not geographic specific or sponsor-specific at present.
The next question comes from Matthew Erdner of JonesTrading.
So you mentioned CLO reinvestment. The first one expires at the end of this year, I believe. How much do you have left there to reinvest?
So it's full today, but we do expect to have a couple of payoffs here in the next couple of months. So it just -- it really depends on whether those happen in time, but we could see a reasonably a reasonably high number. We've got assets in our queue that we're reviewing that we can move in there. We're trying to push people to -- if they're going to pay off to get it done as quickly as possible so that we're able to put new assets into that securitization. I will say, in general, even though we've seen elevated payoffs, they've almost all taken longer than originally projected by the owners. So -- but we are very actively managing and engaging with sponsors to -- not just on payoffs, but obviously, that's a critical component right now -- but just in general. And so we have a pretty good finger on the pulse, but sometimes buyers and sellers, some of it's out of our control. So I do expect to see some meaningful payoff here before the end of the year that we are optimistic we'll be able to put new deals in, in time, but it's all a timing game. After that, it will be just delevering the pool.
Okay. And then as a follow-up to that, now that loans are ramped, is there a plan to kind of address and possibly increase the dividend, especially with that $1.7 million charge being a onetime thing.
Look, obviously, as we said, we do talk about the dividend with the board every quarter. We'll continue to do that this quarter. We are hopeful that based on our pro forma look at our earnings that we're hopeful to see earnings growth. And obviously, we'll talk to the board about how they want to reflect that on the dividend.
[Operator Instructions] The next question comes from Christopher Nolan of Ladenburg Thalmann.
For the new financing, how much do you expect it to add to EPS in 2024?
Jim Briggs, do you want to provide some detail?
Yes. I mean, we've generally not guided from that perspective. I think you can look at the transaction, both the leverage, the cost and the effective spread that Jim is talking about there and make some estimates.
Great. And then on a follow-up on that, I think Jim Flynn mentioned vessel spread of 425 bps, if I heard correctly?
So the second -- for the financing that we just completed, we acquired those loans at a discount, and we equate that to approximately 4.25% we're just north.
Okay, which is above the -- queue says 3.65% spreads.
3.65% is the stated nominal spread. The spread equivalent with discounted fees is what we're estimated to be about 4.25%.
Yes. I mean, Chris, we mentioned -- just a follow-up on that point, that we acquired the loans from an affiliate manager, the majority of our loans at a discount to par of 1.5% or $5.9 million which is driving that effective yield north of effective spread north of 4.25% that Jim has mentioned.
Okay. And then is it fair to say the advance rate on the new financing is slightly below the -- I get 82%, but I just want to make sure I'm in the ballpark.
That's right.
Final question on provisions. Given the new financing, what's the loan loss provision policy on that is? What's driving incremental provisions? Is it the rating on the debt? Is it debt service coverage? Or a little color on that would be appreciated.
Yes. As I mentioned in my remarks, most of the change we saw in the quarter is primarily being driven by changes in the macroeconomic forecast, right? CECL requires you to have a reasonable and supportable forecast period, which we consider to be a year. So that forecast has just gotten a little bit more negative.
The risk rating migration was pretty modest for this quarter. So it's primarily changes in the macro forecast. Different quarter could give a different answer but this quarter was primarily the macro forecast.
This concludes our question-and-answer session. I would like to turn the conference back over to James Flynn for closing remarks.
I just want to thank everyone for joining and expressing interest. We're happy and pleased with getting the transaction done, and look forward to speaking to you all next quarter. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.