Lument Finance Trust, Inc.

Good morning, and thank you for joining the Lumen Finance Trust Fourth Quarter 2020 Earnings Call. Today's call is being recorded and will be made available via webcast on the company's website. I would now like to turn the call over to Charles Duddy with Investor Relations at Lumen Investment Management. Please go ahead.

Thank you, and good morning, everyone. Thank you for joining our call to discuss Lumen Finance Trust Fourth Quarter 2020 Financial Results. With me on the call today are James Flynn, CEO, Michael Larson, President, James Briggs, CFO, and Priscilla Torres, Head of Real Estate Investment Strategies. On Monday, we filed our 10-K with the SEC and issued a press release which provided details on our fourth quarter results. We also provided a supplemental earnings presentation which can be found on our website. Before handing the call over to Jim, I would 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, words such as 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 statement. These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Form 8-K, 10-Q, and 10-K, and in particular, the risk factors section of our Form 10-K. Additionally, many of these risks and uncertainties are currently amplified by and will continue to be amplified by or in the future may be amplified by the COVID-19 pandemic. It is not possible to predict or identify all such risks. Listeners are cautioned not to place any 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. 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 to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. I will now turn the call over to James Flynn. Please go ahead.

Thank you, Charlie. Good morning, everyone. Welcome to Women Finance Trust Earnings Call for the fourth quarter of 2020. Appreciate you joining us this morning. First and foremost, I would like to express my hope that you and your families are all staying well, healthy during the ongoing COVID-19 pandemic. I'd also like to express my optimism that we're all hopeful that we're approaching the beginning of the end of life as we've known it over the past year. So really looking forward to and hopeful that as we enter the spring and summer of this year that we are able to move back to some form of normalcy and then beyond and get through this as safe and healthy as possible. Obviously, COVID-19 has continued to have a significant impact on the economy, our industry, and certainly how we all live and work. Our business and our employees, we continue to seek ways to keep them safe and keep them available to operate with as little disruption as possible. We continue to work from home or primarily work from home since March of 2020, so we're now past the one year mark, but we do hope a return to the office, at least for some, is in the cards for 2021. Despite those challenges, we've been able to execute on all of our investment management, asset management, servicing, portfolio monitoring, and related functions on a daily basis. We continue to, we in Lehman Finance Trust and the manager, along with our parent company leadership, continue to monitor the progress that we've made and continue to be encouraged by the progress and improving circumstances of vaccine distribution and hopefully, if not entirely stamping out, immediately moving toward, again, that sense of normalcy we've all been waiting for for quite some time. Before turning the call to Mike, I wanted to provide a summary of our achievements for the year. As I just mentioned, we successfully navigated the challenging economic environment resulting from COVID-19. As of December 31, 2020, our loan portfolio was 100% performing with no impairments, no loan defaults, or any loans on non-accrual status, and no loans subject to forbearance. Furthermore, we have not granted or needed to grant any single forbearance, and we have not experienced any loan default during the entire period. not just at the end of the period. I believe this is a testament to both our rigorous credit standards as well as our proactive asset management efforts. As a reminder, multifamily assets make up the vast majority of our collateral. We do not own any assets backed by hotels, and we have limited exposure to retail and office properties and other asset types. With regards to shareholder returns, Lumen Finance Trust generated an industry-leading 13% total return inclusive of dividends for the full year 2020. We believe this compares extremely favorably to the competitive set. The number of commercial mortgage REITs in the space had negative returns for 2020, and certain competitors have struggled with loan delinquencies and or margin calls from financing counterparties. From an earnings perspective, we were able to increase full-year distributable earnings by 29% year-over-year from $7.6 million in 2019 to $9.8 million in 2020. During the year or during 2020, our dividend increased meaningfully from 7.5 cents in Q4 of 2019 to 9 cents in Q4 of 2020, representing a 20% increase. We also declared an incremental 4-cent special dividend in Q4 of 2020. From a liquidity perspective, we have not experienced any material adverse liquidity events due to COVID or otherwise. We are comfortable with our current liquidity position based on our current business plan and our structure. I would like to note that we do not currently utilize repurchase or warehouse facility financing at LFC, and therefore we have not been subject to margin calls on any of our assets Our utilization of non-mark-to-mark financing has proved valuable during last year's disruption. Finally, in December of 2020, we announced our rebranding to Lumen Finance Trust in conjunction with the rebranding of LTE's manager from OREC Investment Management to Lumen Investment Management. These overwhelmingly positive feedback from our borrowers and partners on the rebranding We look forward to leveraging the breadth and expertise of the broader Lumet platform in the years to come. 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. On Monday evening, we filed our annual report on Form 10-K and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. The supplemental investor presentation has been uploaded to the webcast as well for your reference. On pages four, five, and six of the presentation, you will find key updates and an earnings summary for the quarter and for the full year. Before I get into our financial results, I want to briefly discuss our non-GAAP earnings measure. You heard Jim mention distributable earnings in his opening remarks. Historically, we have disclosed core earnings as an important financial metric that we use in addition to GAAP net income to assess the performance of our business and a metric we consider when declaring our dividends. Beginning this quarter, we have renamed core earnings, distributable earnings. I want to be clear that this change is only a change in terminology and not how we calculate this metric. We believe this name change better reflects what this non-GAAP financial measure represents, which is a measurement of our results anchored in GAAP net income and adjusted for certain non-cash items that gives a better indicator of our performance within the context of a potential dividend. Others in our industry have similarly moved to change the nomenclature of their non-GAAP measure after discussions with, discussions between the mortgage rate industry and the SEC to adopt terminology that is more descriptive of what the metric represents. For the fourth quarter of 2020, we reported net income common stockholders of 2.5 million, or 10 cents per share, which is in line with the prior quarter. This compares to a net income to common stock holders of 1.2 million or 5 cents per share for the fourth quarter of 2019. The current quarter was primarily impacted by two non-distributable items. The first of these was $177,000 decline in the fair value of our legacy mortgage servicing rights portfolio as we continue to experience elevated prepayment speeds associated with lower interest rates. As of December 31st, the carrying value of this asset was below $1 million. Due to the limited size of this asset, we generally do not expect any future quarterly reductions in fair value to be significant to our earnings. The other non-distributable item experienced this quarter was a small gap income tax benefit of $39,000 pertaining to activity at our taxable REIT subsidiary. After adjusting for these two items, our distributable earnings attributable to common stockholders for the quarter was 2.6 million, or 10 cents per share. This represents a meaningful increase in distributable earnings per share relative to six cents per share in Q4 of 2019, which is driven by higher net interest income, partially attributed to an interest rate environment that has been favorable to our portfolio. We are pleased with the distributable earnings per share yield generated by the company this quarter, which was 9.2% of book equity value on an annualized basis. Our book value at December 31st was approximately $114 million, or $4.56 a share. I would like to highlight that our book value per share has been stable over the last four quarters as we began the year at $4.59 per share, which is within 1% of where we stand today. One additional item which we discussed last quarter that I would like to remind everyone of is that as a small reporting company, as defined by the SEC, we have not yet adopted ASC 2016-13, commonly referred to as CECL, or Current Expected Credit Losses, which is a comprehensive GAAP amendment of how to recognize credit losses on financial instruments. As a small reporting company, we are scheduled to implement CECL on January 1 of 2023. Until then, we continue to prepare our financial statements on an incurred loss model basis. As of December 31st, we do not consider any of our loans to be impaired under the incurred loss model and have not recorded any impairments or allowance for loan losses in the current quarter. While the current performance of our bridge loan portfolio remains healthy, uncertainty about the severity and duration of the economic impact of the COVID-19 pandemic exists. including its impact on our borrowers and on the value of the properties that collateralize our commercial mortgage loan investments. We will continue to evaluate the loan portfolio for credit losses and will record any impairments or allowance as incurred. I will now turn the call over to Mike Larson, who will provide details on our portfolio composition and investment activity.

Thank you, Jim. Good morning, everyone. With regards to our investment activity, during the quarter, we acquired one new loan and made future funding advances on two loans with total incremental fundings of $5 million. All of these fundings were on loans secured by multifamily assets. Since January, we have seen a significant increase in investment pipeline activity driven by a surge in multifamily value-add acquisition activity, newly constructed properties in lease-up, looking for bridge financing, and requests for bridges to permanent agency and FHA finances. In general, market confidence in the commencement of an economic recovery from the COVID environment has positively impacted borrow demand for bridge loans at the onset of 2020. We did experience 56.6 million of loan payoffs during the quarter, and driven by the same uptick in acquisition activity in the market, we expect payoffs to increase over the coming quarters back to a more normalized level. We continue to be thoughtful and patient in our evaluation of new investments, and with the increase in our pipeline, we felt positive about our ability to keep our capital fully deployed. Our overall loan portfolio at quarter end was 90% multifamily in line with prior quarters. Even before COVID, we felt that this focus on multifamily was a strength of ours. But in a post-COVID world, we think that is even more true. Multifamily assets have historically reflected the greatest resiliency amongst the different property types during periods of economic uncertainty. Due to our manager's expertise in multifamily, we continue to anticipate the majority of our loan activity will be related to multifamily assets. Our total portfolio of floating rate loans had an outstanding principal balance of $547 million at quarter end. Portfolio consisted of 40 loans with an average loan size of $13.7 million. which continues to provide for significant asset diversity. Our portfolio has a weighted average spread to LIBOR of 350 basis points. All of the loans in our portfolio have a LIBOR floor above current spot LIBOR rate with a weighted average LIBOR floor of 164 basis points. Should current LIBOR rates persist and you're able to maintain an average LIBOR floor at or near these levels, we anticipate that our LIBOR floors will continue to have a positive impact on our earnings. As of 12-31, our loan portfolio was financed with two series CLO securitizations with an average cost of financing of LIBOR plus 144 basis points. As mentioned before, we believe that the non-mark-to-market match term financing that these CLOs provide give us additional protection relative to alternative financing options. The reinvestment period on our first CLO ended in February of 2020, and our second CLO has a reinvestment period that runs through August of this year. With regards to our first CLO specifically, we experienced $8 million of loan payoffs during Q4. Since the reinvestment period and the securitization has ended, these payoffs have begun to sequentially paint down the CLO bonds. Our total bond paydowns during Q4 were $17 million, which is driven by a combination of that $8 million loan payoff experienced during Q4 and $9 million loan payoff experienced during Q3 of last year, for which proceeds weren't applied to the bonds until the fourth quarter. I would like to highlight, however, that even after the impact of these paydowns, our leverage and cost of funds within the first CLO remain attractive at 80.7% and LIBOR plus 145 basis points, respectively. We do continue to actively monitor conditions in the CRA CLO space, and we are very encouraged by continued positive signs across the commercial real estate capital market. Over the last 90 days, we've seen liquidity return to the secondary market for CRE CLO bonds. And more importantly, we have seen an increase in issuance of managed transactions, as well as significant compression of spreads for new issues CRE CLO deals. These developments provide a positive backdrop to our evaluation of refinance alternatives and the favorable capital market conditions under which we may potentially refinance our CLO.

With that, I'll pass the call back to Jim for some closing remarks. Yep. Apologies for that.

Thanks again, Mike. We do continue to be excited about the progress we've made, and we remain positive about the company's outlook and growth prospects. We look forward to updating you all on our progress and appreciate your time and interest. I'd like to reiterate our hope that you and your families are all staying safe and healthy. And with that, we'd like to turn the call over to questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Steve Delaney with JMP Securities. Please go ahead.

Good morning, everyone. Thanks for taking my question. First off, I'd like to just say congratulations on the progress you made in the dividend. There's no question that that step up, I think it was six and a half, seven and a half, then to nine. Clearly, that was the primary driver behind moving your stock up to where we're near 80% of book as we sit today. Nice job on that. And I think from where you sit, it's not in 2021, as I see it, it's not about growing it further. At this time, it's more about being able to cover it, you know, with the kind of being maxed out on capital and the CLOs coming up here. So I guess my first thing, I think the CLOs are the elephant in the room. Mike, if you could comment The great news is you're not getting killed with paydowns and you've got some room to run on FL2. The great news is the market's hot, right? I mean, I'm sure you saw the Arbor transaction that was reported Monday morning, five turns of leverage, 133 weighted average. As you look at your two CLOs and your options, I know you can't be specific. Do you need to have, is it better to have two separate issues or do you get some benefit in the marketplace if you were to combine the two transactions and do one new larger transaction? Let's start there.

Sure, sure. I'll jump in and I would please add. So there is, specifically on that last question, There are some benefits to a larger transaction and the diversity that provides and the levels that can improve the economics of the CLO. So there's something we're looking at. As we've said in prior quarters all through last year, we've continued to very actively monitor the market and evaluate when the right time is to refinance our CLOs. As you said in my remarks, despite some of the paydowns we've seen, the pricing and leverage on our existing CLOs remains attractive. But clearly that's not going to continue forever as those bonds continue to pay down. So we are very actively looking at the market and looking options to refinance one or both CLOs. And as you noted, the market has improved substantially, particularly even over the last few months, which is great and positive. And we're glad to see that. I think that bodes well for us as we look to refinance our CLOs.

Yeah. Okay. Well, we'll stay tuned. Clearly, Having that resolved, we'd love to see the company have more capital and grow. I think accessing capital when there's a big question on the CLO near term makes that more challenging. So it sounds like you've got it all figured out, which I know you did. Just one quick one for Jim Flynn. You've done the rebranding, okay, and obviously for what we care about here today, Lumen Finance Trust, the REIT. What name, in terms of just operating, businesses like Red Capital, how do they refer to themselves in the marketplace now? Because, you know, I know you're climbing the league tables with Freddie and Fannie on small balance.

Yeah, so Lumen has absorbed all of those names. Okay. So what was, you know, Hunt Real Estate Capital, which was acquired in January of 2020, Red Capital, Lancaster Pollard, and even, you know, kind of what I'll call the Oryx-branded balance sheet lending is all going to be incorporated and is incorporated into that Lehman brand that is the manager of the finance trust here. So those names, including red, you know, are now gone. Obviously, they existed. You're there in places on documents that are quite old. But going forward, it will only be the Lumet name.

It's the Lumet brand, but if I were to Google it, it's Lumet what? Is it Lumet mortgage lending multifamily? How do you refer to it in the marketplace?

So for the mortgage banking, particularly with Fannie, Freddie, FHA, we've just used Lumet. Okay. So it doesn't, it's single name.

Yeah.

So if you go to inlumen.com, that's what would, that's what would show up. Great. And so that, so we're just trying to, you know, we're like Madonna, Steve.

Yeah, exactly. You don't, who needs two names, right? There you go. Madonna, Gaga. There you go. Okay. Well, thanks for clarifying that. And hopefully it becomes, it's going to be a really strong brand. Listen, thanks for the time and the comments. And last thing I just, I want to say thanks to Jason Stewart at Jones for picking up coverage. It's nice to have somebody else on the story and look forward to moving forward with him as well. Thank you.

Yeah, thank you, Steve, and thank you for your continued support. Thank you.

Again, if you'd like to ask a question, please press star, then 1. Our next question comes from Christopher Nolan with Ladenburg Salmon. Please go ahead.

Hey, guys. How much reinvestment capacity is left in the CLO, which is non-runoff?

CLO2.

I'm sorry, what was that?

You're just referring to the second CLO that has reinvestment capacity, correct?

Exactly. I'm just trying to find out how much.

As of today, or it wouldn't be today.

Chris, just for clarity, is your question on how many months remaining or on dollar now?

Sorry. No, I'm just trying to see whether you have any reinvestment capacity in that second CLO to offset the runoff of the first CLO.

So capacity.

That's okay. You can get back to me later. It's no big deal.

No, no, that's fine. As of the end of the year, there was 58 million in capacity within that CLO.

Great. And then turn to the multifamily real estate market. Appreciate the color that you guys provided. What sort of, the market tends to be a bit competitive. What sort of LTVs and interest coverage ratios are you seeing on deals that you're underwriting?

Priscilla, you want to? Sure.

So to answer that question, a good way to answer it is to also put it in the backdrop of what was going on pre-COVID. So pre-COVID, I'd say the LTVs that you have to underwrite to going in are 80%. Nowadays, they were up to, I'd say, mid-70s. It's frankly slowly creeping up with competition. But right now, for the most part, going in LTVs are call it 75%. With respect to DSCR, because LIBOR is obviously very low, DSCRs are actually less of a challenge right now on a going-in basis. So it's actually, and also in conjunction with the compression of spreads that we're seeing, they're pretty reasonable, except for obviously lease-up assets where the coverage is negative. But in those cases, that service reserves are being structured.

Okay, and I guess as a follow-up to that, given that real estate's pretty sensitive to higher interest rates, if interest rates were to go up, obviously I think your LTV would be going down just because the value of the property would be going down. How would you address that if your LTV, actually I guess your LTV would be going up, excuse me, How would you address that if your LTV started going higher than 80% if we have a material change in interest rates going forward?

Okay. A couple of things. The metrics I discussed were what we call going in LTV. And as you can appreciate, because these are transitional assets, ultimately what the transactions typically work towards is an accretion of value as the business plans are executed. As a result, the LTVs that we end up with as the term continues goes down. So in the case, for instance, of an 80% LTV loan, and again, to be clear, that was pre-COVID. Right now, it's more in the mid-70s. The going out LTV will be closer to low 70s in terms of the market today. In a number of occasions, actually, we've seen it going down to even below 70%, call it high 60s. With respect to your question on value and interest rates, as I'd say even the past 10 years have shown, and certainly the recent periods, there is a stickiness, if you will, to cap rates. And in fact, what's more relevant is what I'd call the delta, if you will, between cap rates and where treasury rates are today. And that dealt, I'm reluctant to quote it because I don't have the chart in front of me right now, but it is significantly higher than what the historical average is. So in other words, in our view, and in a number of real estate economists' views, there is significant runway for rates to go up before cap rates even start to go up. So as a result of that, with respect to your question, and in fact, I asked a real estate economist that question very recently. What he expressed is, and I shouldn't cite him just because I'm not sure. There are studies on this, though. The concern on cap rates going up relative to where interest rates are, it's still a few years away in terms of concern because of that significant delta right now.

Got it. Thank you for the clarification. Final question. Do you guys have any loan exposure in New York City, Los Angeles, San Francisco, Chicago?

Go ahead.

I'd like to just give the context here of, as you all know, the focus of Blument has always been middle market workforce housing, which tends to be in the, if you will, center of the country and less so in the coastal areas, the east and the west coast. As a result of that, in terms of New York City and kind of the major markets in California, we have, if your concern is in terms of the COVID impacted geographies, it's next to, it's de minimis, I would say. and the focus actually of the geographies we've had historically are fortuitous with respect to the demographic movement since COVID.

Great. That's it for me. Thank you for taking my questions. Thank you.

Thanks, Chris.

This concludes our question and answer session. I would like to turn the conference back over to Mr. Flynn for any closing remarks.

Thank you, Operator. I'd just like to reiterate my thanks for the support from those who joined, and we look forward to speaking to you again next quarter.

Thanks, all.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.