Claros Mortgage Trust, Inc.

good morning ladies and gentlemen thank you for standing by the call will shut start shortly in a few moments Thank you. Thank you. Thank you. Thank you. Welcome to today's Claros Mortgage Trust second quarter 2022 earnings conference call. My name is Candice and I will be operator for today's conference. All participants will be on listen-only mode. After the speaker's remarks, there will be a question and answer period. All lines will be muted during this presentation portion of the call. With an opportunity for question and answer, At the end, if you'd like to ask a question, please press start followed by one on your telephone keypad. I would now like to hand the call over to Arne Wim, Vice President of Investor Relations for the Carlos Mortgage Trust. Please proceed.

Thank you. I'm joined this morning by Richard Mack, Chief Executive Officer and Chairman of Claris Mortgage Trust. Mike McGillis. President and Director of Claris Mortgage Trust, and Jay Agarwal, CMTG's Chief Financial Officer. We also have Kevin Cullinan, Executive Vice President, who leads MREX Originations, and Priyanka Garg, Executive Vice President, who leads MREX Portfolio and Asset Management. Prior to this call, we distributed CMTG's earnings supplement. We encourage you to reference these documents in conjunction with the information presented on today's call. If you have any questions following today's call, please contact me. I'd like to remind everyone that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our other filings with the SEC Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will also be referring to certain non-GAAP financial measures on today's call, such as distributable earnings, which we believe may be important to investors to assess our operating performance. For non-GAAP reconciliation, please refer to the earnings supplement. I would now like to turn the call over to Richard.

Good morning and thank you everyone for joining us for CMTG's second quarter earnings call. CMTG delivered another strong quarter as we continue to gain momentum across our strategic priorities in originations, asset management, and capital markets activity. During the second quarter, we originated approximately $1 billion of new loans, reflecting our continued focus on the residential sector and high growth markets such as Dallas and Atlanta. Our asset management team also made significant progress during the quarter. As noted on our last call, we successfully resolved our largest non-accrual loan, driving a positive outcome for our stakeholders and significantly reducing non-accrual loans to approximately 2% of the portfolio. And we continue to make progress towards future resolution of these remaining non-accruals. I'm also happy to report that despite the choppiness in the capital markets, We further enhanced our financing capabilities by securing an additional $150 million bridge acquisition facility. As I look to the broader markets, heightened market uncertainty has become the prevailing theme challenging investors across asset classes. Record inflation levels, disrupted supply chains, tightening monetary policy, and geopolitical challenges had until recently dominated headlines. But now mixed economic data is part of the analysis. Considerations include sectors of slowing economic growth, areas of rapid inflation, areas of minor inflation, higher borrowing costs, weakening corporate margins, a strengthening dollar, declining of volatile commodity prices, and inconsistent corporate commentary. These are conflicting signals. and they cloud the economic picture and further complicate the narrative for potential economic outcomes. And so it's no surprise that there's still much debate about whether the Fed can engineer a soft lending. Here at CMTG, we think a modest recession is the likely outcome, but it's far from a certain one. What is certain is that the discussion continues to evolve and broaden in scope and complexity as we further contemplate the interconnectedness of the U.S. economy and other major economies and what that means for our economic outlook here in the U.S. and in real estate more specifically. On a positive note, transitional real estate lending continues to be a bright spot in today's investing environment as the opportunity set for alternative lenders has become increasingly attractive. particularly for floating rate strategies like the one that CMTG employs. Over the past several months, we've observed credit spreads widen dramatically as banks in the securitization market reduce their appetite for risk. On top of this, interest rates are also increasing at a record pace. This has set up our new originations for potentially better total returns for the same amount or less risk than what was possible just six months earlier. Further, it seems that recent rate hikes and potential future increases will continue to provide tailwinds to our sector and greater returns. Longer term, however, we could see some credit spread tightening as absolute turns continue to climb to a place where we believe capital flows will be diverted into our sector. Amidst this positive environment for transitional real estate lending, it is important to acknowledge that rising benchmark rates and widening credit spreads are creating uncertainty surrounding equity valuations, which we believe need to adjust downward for any asset with medium to long-term leases with modest to no rent escalations or lying outside quickly inflating rental markets. Thus, it is not surprising to note that the public equity REIT markets are already reflecting a decrease in property valuations. Given this backdrop, CMTG has been focused on lending to rental housing assets with short-term leases and high growth under supplied markets where cash flows are likely to increase more rapidly. When real estate values are uncertain and assets with stable cash flow may be devaluing, we believe that CMTG's strategy of participating in the capital stack as a debt provider Specifically, at an attachment point where our position as significant subordinate capital to protect our investment is as relevant as ever. And I believe that this is one of the best times to be a lender in the property sector that I've seen in my career. But it is not just being in the right sector at the right time that allows CMTG the opportunity to succeed. It is the institutional nature of our platform. It's established investment processes and procedures combined with the multi-generational and multi-cyclical experience that the Mack Real Estate Group has as an owner, operator, manager, and developer. We believe these factors will continue to be the essential drivers of our performance. Our investment strategy focuses on transitional lending opportunities secured by high-quality assets backed by institutional-grade sponsors. We originate primarily floating rate senior loans at compelling LTVs, targeting major markets and select high growth markets. As one of the largest commercial mortgage REITs, we have the scale to provide lending solutions to some of the most well-capitalized real estate sponsors in the world. In addition, our reputation and experience have enabled us to develop trusted and durable financing relationships as we have scaled our business. We believe that the access to liquidity enabled by these relationships will become increasingly important as certain financing counterparties become more conservative or even choose to sit on the sidelines. Our recent $150 million bridge acquisition facility closing amid the capital markets turmoil demonstrates our ability to access incremental capital during a period of stress and speaks to the strength of CMTG's credit quality and our capital markets team. As we look ahead, it's the sum of these parts that we believe will drive our success. Experience, capabilities, relationships, access to capital, the strength of our balance sheet, its low leverage, and access to financing. We are fortunate that Prudence has allowed us to carry a higher cash balance at a time when spreads and rates are increasingly lender-friendly. Therefore, we believe we are well positioned right now to be highly selective and opportunistic in this dynamic market as opportunities continue to unfold. I would now like to turn the call over to Mike McGillis to discuss the portfolio.

Thank you, Richard. We have been migrating our portfolio to asset classes that we view as defensive in nature and the sectors exhibiting strong underlying supply-demand fundamentals. continued revenue growth at the asset level in addition we continue to deploy capital to select high growth markets demonstrating favorable demographic trends and job and wage growth our second quarter originations activity reflects our continued focus on these high conviction themes during the second quarter we originated approximately 1 billion in total loan commitments across eight investments bringing year-to-date 2022 originations to $2.2 billion. Approximately half of our second quarter originations were in the multifamily sector, which resulted in a 9% increase quarter-over-quarter in our multifamily exposure. In addition, we continued to add build-to-rent and industrial investments to the portfolio while capitalizing on attractive opportunities that we sourced in the hospitality and mixed-use sectors. Multifamily continues to represent our largest property type, comprising 41% of the portfolio's UPB at June 30th, and we expect multifamily to continue to be an overweight allocation for us. For example, we originated a $152 million floating rate loan collateralized by a portfolio of multifamily assets in Dallas, Texas. The borrower here is well known for its extensive value-add experience and significant presence in this market. The business plan is responsive to the demand for renovated multifamily product in a desirable submarket of Dallas that has demonstrated strong double-digit rent growth and low vacancy rates. Our portfolio UPV has remained relatively unchanged quarter over quarter at $7.1 billion. initial and follow-on fundings offset the elevated volume of repayment activity we experienced during the quarter. Of the $782 million in repayments, including the loan sale proceeds from the non-accrual loan Richard mentioned, $562 million were collateralized by assets located in New York, which contributed to the 8% quarter-over-quarter decrease in our New York exposure. The reduction in New York exposure represented a mix of property types, including hospitality, office, for sale condo, mixed use, and land. As previously mentioned, one of our priorities has been to further diversify our portfolio by geography, and we believe we've made excellent progress on that front. As of June 30th, New York represented 25% of the portfolio compared to 44% for the same period a year ago. And with the exception of California comprising 21% of the portfolio and the DC Metro area comprising 12% of the portfolio, no other state represented more than 10% of the portfolio. In addition, we've been deploying capital and increasing our presence in Texas and Georgia, which represented 10% and 8% of the portfolio respectively at June 30th. As Richard mentioned, we successfully resolved our largest non-accrual loan during the second quarter, a $116 million New York land loan. Given our ownership mindset approach towards lending, we believe we can benefit from taking a longer duration view on certain investments given our conviction in our underwriting and the quality and basis of the underlying collateral. This land loan provides a good example of how our investment and asset management approach enabled us to deliver an attractive outcome for our stockholders. The investment generated a levered gross return of approximately 12.5%, and we recorded a $30 million or 21 cent per share gain during the second quarter as a result of this resolution. I would now like to turn the call over to Jay.

Thank you, Mike and Richard, and good morning, everyone. For the second quarter, we reported distributable earnings excluding realized losses of 71.5 million, or 51 cents per share. This compares to the prior quarter of 33.5 million, or 24 cents per share. GAAP net income was 63.2 million, or 45 cents per share. The quarter-over-quarter increase in distributable earnings was primarily due to one, 21 cents per share gain resulting from the resolution of the non-approval land loan, and two, improved operating performance of our New York City REO Hotel portfolio that contributed three cents per share to distributable earnings compared to a loss of three cents per share last quarter, so a swing of six cents per share. We also recorded a charge of $11.5 million, or eight cents per share, against a $15 million loan that is a non-accrual status. This loan is secured against the estate of a former borrower and previously had a $6 million CESA reserve against the loan. This quarter, based on a proposed settlement offer, we recorded an additional $5.5 million CESA reserve and charged the total $11.5 million reserve as a realized loss from a GAAP standpoint. We now expect to collect $3.5 million against this loan. Our general CESA reserves stand at 73 million, or 1% of our outstanding principal balance. This is an increase of 3 million over the last quarter, primarily due to portfolio growth and macroeconomic assumptions. Turning to liquidity, we ended the quarter with over $460 million in cash. and $735 million in unencumbered loan assets. We entered into a $150 million bridge acquisition facility that enabled us to close loans unlevered, giving us up to six months to seek optimal financing. We continue to carry excess liquidity for both offense and defense. With respect to interest rates, after the recent increases in interest rates, we are now asset sensitive as we pass the crossover point where our portfolio earnings are positively correlated with increases in benchmark rates. We estimate that a 100 basis point increase in rates over spot rates at June 30th would result in an annual increase in net interest income from our existing portfolio by 12 cents per share. Rates have already increased and continue to rise since June 30th. At quarter end, our leverage remained at 1.9 times, which is one of the lowest in the industry. We expect this to increase as we deploy additional capital and still maintain a target leverage level of 2.5 to 3 times. Lastly, the CMTG stock was added to the Russell family of indices during the quarter, as we continue to see an increase in daily trading volumes in our stock. I would now like to open the call for questions. Operator, please go ahead.

Thank you. If you would like to ask a question, please press Start followed by 1 on your telephone keypad. If for any reason you'd like to remove your question, please press Start followed by 2. Again, to ask a question, it is Start followed by 1. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. So our first question comes from the line of Rick Shane.

JP Morgan your line is now open please go ahead good morning everybody can you hear me yes excellent um hey Richard so I think I'm hearing in some ways two things from you and and I'd love to sort of reconcile them in one way I think you're saying hey I The markets are dislocated. When investors are scared, it's a good time to be putting capital to work. And you position yourself well to do that. And I realize that can be a little bit unnerving, but I think it makes sense. At the same time, when we look and think back about what we've heard in earnings calls this quarter, the sort of consensus trade continues to be multifamily Sunbelt. How do you reconcile the idea of being contrarian with also how crowded potentially that that particular niche could be?

Well, thanks for the question. Right. And I think I don't think there's actually a reconciliation needed. We are perhaps not being as opportunistic as we could be because what we're able to do is invest in a consensus that as a lender make returns in cash flowing assets that we might have previously had to make a construction loan to achieve a similar return. So we are basically because of the backup in the market taking a pretty conservative approach as to what we're lending on and the LTV, LTC that we're lending and because of the backup in the market are able to achieve returns that are very similar for less risk than we were doing before. So it may be that we're not being as opportunistic as we can be at all times We're going to be selective about construction and alpha generating trades. But we feel pretty good that we can move down in risk and make similar to better returns. So that's kind of the way we've been playing the market here. And I think we will continue to kind of barbell this with, more conservative cash flowing Sunbelt Multi where we see the demographic demand as being very strong and we think as close to recession proof as we see and also with short term leases that can take advantage of the inflating market and protect you against interest rate moves. And so we'll continue to do that where there's a capital shortage and be opportunistic We really think we're getting paid to take more risk. Hopefully that was responsive.

Very responsive, very helpful, and gives a lot of insight and helps me understand what's going on much better. So thank you. Thank you.

Thank you. Our next line, our next question comes from the line of Don Sandetti of Wells Fargo. Your line is now open. Please go ahead.

Yes, can you talk a little bit about your expectations for net portfolio growth over the next few quarters? It looks like Q3, the portfolio may have declined a bit, and kind of how this all ties into your ability to cover the dividend with core earnings.

Jay or Kevin? Yeah, it's a function of repayments, Don. You know, the more repayments, we get, the more we can grow the portfolio. But in terms of your second question about covering the dividend, we feel good about covering the dividend, especially where if you look at the forward curve so far and if you look at page 16 of our deck, we are now asset sensitive and any increases in interest rates go straight to the bottom line. based on a combination of – or in spite of slower deployment pace and slower repayment pace, we expect to cover the dividends for the full year.

But in terms of net portfolio growth, you shrunk a little bit this quarter, and it looks like based on what we've seen for Q3 that it declined a little bit more. Do you expect that to continue to moderate? And then can you just talk a little bit about deal flow on the ground? Is there enough activity to kind of replace the repayments?

Yeah, I'll start. We are sitting on $460 million of cash, so we are being very selective in where we're deploying. There are lots of opportunities that we are seeing, and Kevin can add more color on market, but if repayments also will drag on, meaning outstanding loans on the ground will, if they do not pay, those loans might extend, and that will help us generate further earnings.

Kevin Cullen here. I'll chime in on sort of the opportunity set at hand. It continues to remain very robust in our perspective, and there are a lot of opportunities that we're constantly and regularly evaluating to redeploy capital as we are receiving repayments. And I would go so far as to say, and this kind of mirrors or echoes what Richard had said earlier, that we feel like we can do that at an accretive level in this spread and interest rate environment to some of the repayments that we are receiving at this point in time. So we remain bullish on being able to recycle capital into an accretive into accretive and perhaps even less execution risk assets.

Yeah, no, and definitely, look, it's great to see the repayments, particularly given the New York exposure and the history. So I was just trying to get a sense if you think you can, you know, get back to a growth mode. So thanks.

Thank you. Our next question comes from the line of Jade Rahami of KBW. Your line is now open. Please go ahead.

Thank you very much. Away from multifamily and the Sun Belt, which you characterized as defensive, where are you seeing the best opportunities? Can you give any color on the types of situations? Sure, Jade.

I can take that, Jade. Um, so away from, um, the multifamily trade, which we've obviously been very active in, uh, we have, um, closed on and are working on a few, what we would refer to as, as higher end, um, leisure driven hospitality assets, where we think there's still, um, you know, really good relative value. That's, that's not withstanding the structural protections and the underwriting that, that we're implementing to reflect what could be, you know, what could be, um, some meaningful economic uncertainty. over the term of the loans that we're working on right now. But that is a spot in the market that the assets are performing well. They're recovering very well coming out of the pandemic. We see fairly consistent ADR, REVPAR occupancy growth throughout 2022 and forward bookings, importantly. And it's a little bit of a less crowded space in terms of our competition. So we do expect to continue to look at those and evaluate those. but be very selective not only on the assets but also at the levels that we're willing to invest in in those particular capital stacks. And then another one which we, you know, we feel like we have a little bit of an edge on is certainly the industrial sector. We did close an asset in the second quarter in the industrial space that, you know, heavily structured and credit enhanced by not only the borrower but a partner. that has a forward takeout of that asset down the road. So we're very happy with the risk adjusted nature of that and working on some similar type investments where we're generating some alpha meaningful credit enhancement by virtue of deposits on hand, cash on hand, as well as forward takeouts of some of those assets. So I would say away from multifamily where we see some very attractive relative value, if you can sort of cut through some of the noise, is lease-driven hospitality and new-built industrial.

On the multifamily side, with respect to defensiveness, historically rents have not declined, gone negative during periods of economic softness. However, we've been in a period of extremely robust inflation and rent growth as well as the multifamily sector being, I would say, the darling asset class over the last 10 plus years. So as you're underwriting deals, how do you account for a correction in multifamily values that I believe is underway and also moderating rent growth outlook in your underwriting?

Thanks for taking the question. Great question, Jay, and happy to take that as well. I'd say it's twofold. We're expecting rent growth to at a minimum decelerate in many of the markets that we're working on and that we're looking at. And we're underwriting those assets accordingly. I'd say more importantly, at the levels that we are lending at and investing at, we are going in at debt yields or cap rates to our position that we feel are protected day one and not relying on future rent growth. So the rent growth is obviously upside and important to the equities business plan. But when we're going in at mid-single-digit debt yields, perhaps there is a little bit of upside to a rent roll. Perhaps there is some future rent growth in the market. We're trying to size our positions where we're not relying on that whatsoever and that we're at a debt yield that is supported by forward-looking cap rates with some assumptions on interest rate movements over time and where we expect the 10-year to be when we're looking at whether it's initial maturity or beyond that. We're eyes wide open to it, and we feel like we're picking our spots appropriately and not relying on that type of future growth. I think everyone can come to the conclusion that it's difficult to sustain in the long term.

Thank you.

Thank you. As a reminder, if you'd like to ask a question, please press star followed by one. Our next question comes from the line of Steve Delaney of JMP Securities. Your line is now open. Please go ahead.

Good morning. Thanks for taking my question. We're starting to hear some signs because of repricing of credit in the marketplace for comparable assets, say, today versus six months ago. Can you comment on that and your spreads over LIBOR that you're achieving on comparable loans? Where would you say that has moved, say, in the last 6 to 12 months? Thank you.

Thanks, Steve. I can take that again. I would say I'll focus on the last 6 months because in this market and in this environment, 12 months feels like a pretty distant memory at this point. Exactly. Apples to apples risk on apples to apples asset classes and business plans. I would say over the last six months or perhaps since the end of the year, we could say spreads are probably out a minimum of 100 basis points. But, you know, unfortunately, and we should say this, you know, some of that is being driven by the bank financing market or the lack of securitizations that have become a little bit available in the market. So that's not all ROE, but certainly we're seeing, you know, ROE growth or net interest income on those underlying assets that is accretive to our position and accretive to the portfolio in the long term. But we're definitely having to work harder on the liability side of the balance sheet to make sure that we're putting together the optimal capital stack.

Got it. Got it. So obviously you had a billion come in and then six, 700 or so go out in new loans. So I assume the way you're describing that, Kevin, is pretty much the newer loans going out have the stronger spreads versus what paid up. So on the left-hand side of the balance sheet anyway, your returns are improving. That's an answer.

The whole loan yield is definitely going out in new investments at higher levels than repayments, generally speaking. And, you know, we're very focused on making sure that we're optimizing the capital stack.

The repricing that you're having to negotiate on your financings, would you describe that as broad? I mean, is this sort of a market-driven thing, or is it a particular bank who's, you know, reducing, trying to tighten up their credit box? Or is it just all the banks are kind of in lockstep on the financing?

I can take that to you. Yes, Steve. Thanks, Jay. It's repricing of – just to be clear, it's repricing of credits on new financings, not existing financings.

Oh, yes.

Exactly. It's a function of – it varies bank by bank. There's one or two banks who are just not doing any new business, but for the most part, banks are quoting loans just at wider spreads than they were previously. We've been in a good position – We've been in a good position to obtain financing, both from our warehouse counterparties, but also from note-and-note format. So we are in a good position. Banks have become more selective in terms of who they will lend to, and I think banks are concentrating their lending platform to larger players like ourselves.

Thank you both for your comments.

Thank you. As there are no more questions registered at this time, I would now like to turn the conference over to Richard Mack for closing remarks.

Thank you, and I just want to thank everyone for joining. In response to some of the questions, I would finish off by saying we have capital to deploy, and with repayments, we'll have more. It's a really good time to be a lender. It's, I think, in many ways, a tough time to be a borrower. And I think we're in an environment where we can be in growth mode and also reducing our risk in terms of the amount of cash flow assets that we're lending to and diversifying our portfolio, particularly by lending to multifamily in high growth markets at cap rates where we don't need much rent growth at all. And these are assets that, you know, follow our mantra. They're assets that we want to own in markets where we have a lot of experience and expertise, you know, at a basis we find compelling, which is kind of the way we look at the world. And we're getting spreads that previously have been associated with heavy transitional for light transitional. We really like that trade. As Kevin mentioned, we also have an ability to get industrial exposure in a way that we haven't in the past. And we are going to continue to pepper our portfolio with alpha generation in terms of continuing to exploit our capabilities around development and making some construction loans, particularly in the industrial sector, and also making loans in the hospitality sector to create alpha where we really see mispriced opportunities. And so I think it's quite an exciting time. uh, to be a lender, um, despite concerns around asset valuations, um, given the amount of subordination of capital that we are able to get, um, because of the backup in the capital markets. So, um, I want to thank you all for, for listening and, uh, just give you a sense of, of how bullish we are right now about the environment. Um, and, uh, I look forward to talking to everyone again on the next quarterly call.

Ladies and gentlemen, that concludes today's conference call. You may now disconnect your lines.