Lument Finance Trust, Inc.

Good morning, and thank you for joining the Lumen Finance Trust second quarter 2021 earnings call. Today's call is being recorded and will be made available via webcast on the company's website. I would like to turn the call over to Charles Duddy with Investor Relations at Lumen Investment Management. Please go ahead, sir.

Thank you, and good morning, everyone. Thank you for joining our call to discuss Lumen Finance Trust second quarter 2021 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 10-2 with the SEC and issued a press release which provided 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, 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 the COVID-19 pandemic. It is not possible to predict or identify all such risks. Listeners are cautioned not to place undue reliance on these forward-looking statements or speak only to 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 to the most preparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at sec.gov. I will now turn the call over to James Flynn. Please go ahead.

Thank you, Charlie. Good morning, everyone. Welcome to the Lumen Finance Trust earnings call for the second quarter of 2021, and thank you all for joining. This quarter was a busy, important, and successful quarter for Lumen Finance Trust growth and growth strategy. During the quarter, we executed several significant capital transactions that allowed us to grow our capital and institutional investor base. At the same time, we made significant incremental investments, observed continued strong performance in our portfolio, and maintained distributable earnings consistent with our prior quarters. This all accomplished in an environment marked with uncertain economic data, interest rates, unemployment, asset values, as well as health data with respect to COVID-19 and the variants, specifically the Delta variant, now appearing throughout the country and world. The first of our major transactions was the issuance of the perpetual preferred equity that we discussed during our prior call, raising 58 million in net proceeds. Secondly, and as previously announced on June 14th, we successfully closed a $1 billion CRE CLO. In conjunction with this transaction, we redeemed our two prior CLOs. This new CLO provided us with an attractive leverage and pricing on a non-recourse, non-mark-to-market, and match-term basis. Our utilization of the CLO market proved valuable during last year's disruption, and we continue to see this as an attractive way to finance our investment portfolio. In closing of this, our largest CRE CLO represents another significant positive milestone in the progression of our growth plans. Importantly, this transaction allowed us to quickly deploy a portion of the proceeds from our preferred equity offerings while still providing favorable economic and structural features to allow for continued growth. The CLO allowed us to increase LFT's total assets on balance sheet by 85% from 567 million as of 3-31 to 1.04 billion as of June 30. In addition, combining our two prior CLOs into a larger single transaction allowed for increased economies of scale and facilitates greater investment diversification. We believe the strong execution for this CLO, along with our successful preferred equity offering and the increase in our term loan, reflect noteworthy market and investor interest in our company and in our future. In the coming months, we hope to continue discussions with investors and educate market participants about the LFT and the opportunity we provide for investors. Although LFT is relatively small in the commercial mortgage REIT space, our manager and the larger Lumen platform are not. Our manager is one of the nation's largest capital providers in the multifamily and seniors housing space, executing over $16 billion in total transaction volume in 2020, servicing a $47 billion loan portfolio and employing nearly 600 employees in over 25 offices nationwide. The scale of this platform benefits the investors of LFT and provides great support in the execution of our investment strategy. As we have continued to show over the last three years, we are utilizing the strengths of our manager to focus our investments in middle market multifamily floating rate bridge loans that have continued to perform extremely well, even in the very challenging economic environment last year. Although there has been increased competition for these investments with numerous new debt funds entering the space, the breadth of Lumen's platform and the strength in multifamily in particular continues to provide us with compelling investment opportunities. During the last three months since our preferred offering, we have invested over $530 million in new floating rate bridge loans, showing our ability to quickly deploy substantial amounts of newly raised capital. This strong deal flow is driven by the expansive origination capabilities of our manager. In addition, we have seen tremendous transaction activity in the first half of the year as the market responds to the COVID recovery, albeit tempered by the recent increases seen in cases around the country. As we continue to grow, we will also identify other investment opportunities in commercial real estate debt to diversify and invest a portion of our capital into asset classes such as preferred equity, MES loans, and other high-yield debt securities. While we are proud of the capital raising and deployment achievements this quarter, it is important to acknowledge that our focus in multifamily bridge lending and the strength of our credit and asset management platform have allowed us and our portfolio to continue to perform admirably. As of June 30th, our loan portfolio was 100% performing with no loan impairments, no loan defaults, and no loans subject to forbearance. Furthermore, we have not granted a single forbearance nor have we experienced a single loan default during the COVID era. I believe this is a testament to both our rigorous credit standards as well as our proactive asset management efforts. And perhaps most importantly, Our ability to continue to execute our business plan is reflected in our results. Our distributable earnings for the quarter was 11 cents per share, consistent with last quarter. Inclusive of this quarter, we have produced 43 cents per share of distributable earnings over the prior four quarters, representing consistent earnings that provide strong support for our dividend. When this management team took over as manager of Lumen Finance Trust in January of 2018, We were clear on our goal of deploying our capital into commercial real estate debt investments with a focus in multifamily in order to provide stable earnings that support a market return to our shareholders. We also indicated our desire to grow LFT to a larger scale, which we felt would provide value to our shareholders. With the recent CLO refinance and preferred offering, we're continuing to make progress towards these goals, and I am excited about our continued growth as we focus on executing the business plan. 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 quarterly report on Form 10-Q 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 5, 6, and 7 of the presentation, you will find key updates and an earnings summary for the quarter. For the second quarter of 2021, we reported net income to common stockholders of approximately $955,000, or $0.04 per share, which represents a decline relative to Q1 2021, net income to common stockholders of $2.8 million, or $0.11 per share. However, the current quarter was meaningfully impacted by certain non-distributable earnings adjustments. After adjusting for these non-distributable items, LFT's distributable earnings per share of common stock was $0.11 per share, which, as Jim mentioned, is in line with the prior quarter. The first of these adjustments was $1.7 million, or $0.07 per common share, lost on extinguishment of debt. This loss on extinguishment of debt was caused by the unwind upon CRE 2018 FL2, which was refinanced during the quarter. The 1.7 million loss represents an acceleration of deferred financing costs incurred at the closing upon CRE 2018 FL2, which were not yet amortized to interest expense at the time of three finance. As of June 30th, And as of today, the company does not expect any additional losses or expenses associated with either of LFT's two previous CRE CLOs. There were two other non-distributable items experienced during Q2. The first of these was $220,000 unrealized loss on mortgage servicing rights, which was driven by higher realized prepayment speeds in our legacy residential MSR portfolio. I'd like to note that as of June 30th, the carrying value of our legacy MSR asset was less than $700,000, and therefore we do not believe that any future changes in the value of this asset should be a meaningful driver of earnings. The final non-distributable item incurred during Q2 was a $54,000 income tax benefit associated with activity at our taxable REIT subsidiary. In his opening remarks, Jen mentioned the successful closing of a preferred equity offering on May 5th, and the successful closing of our CLO refinance on June 14th. As we work to deploy the proceeds from these transactions, we may see short-term declines in our net income and distributable earnings to common shareholders over the coming months. We expect any such declines to be transitory in nature. We do not anticipate any negative impact to our medium-term or long-term earnings outlook. However, this risk does exist in the short term for some drag on net income to common stockholders during this capital deployment phase. Our total stockholders' equity at June 30th was $170.1 million, which represents a $56 million increase relative to the prior quarter's total stockholders' equity of $114.2 million. This increase was driven by the successful execution of our preferred equity offering during the quarter, as previously discussed on the call. A common book value per share was $4.41 as of June 30th. This represents a 17 cent per share or 3.7% decline relative to the March 31st common book value per share of $4.58. With regards to this decline, I would like to note that the book value per share of common stock is net of 2.7 million or 11 cents per share of preferred stock offering costs incurred during the quarter. Book value per share of common stock was also negatively impacted by the $1.7 million loss on extinguishment of debt that I previously referenced. Excluding the impact of these non-recurring items, LFT's book value per share of common stock would have increased by one cent per share quarter over quarter. As discussed in prior quarters, I would like to remind everyone that as a smaller 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 gap amendment of how to recognize credit losses on financial instruments. As a small reporting company, we are scheduled to implement CECL on January 1st, 2023. Until then, we continue to prepare our financial statements on an incurred loss model basis. As of June 30th, we do not consider any of our loans to be impaired under the incurred loss model, and we 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 COVID-19 recovery 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. As a quick note, with respect to our common dividend, in accordance with normal course timing and process, we have not yet made a dividend declaration for the third quarter of 2021. We expect to make a determination of our dividend in September after discussing with our board in normal course. I will now turn the call over to Mike Larson, who will provide details on our portfolio composition and investment activity.

Thank you, Jim, and good morning, everyone. As Jim mentioned, the last several months have been very active from an investment standpoint. During Q2, we acquired 41 investments from an affiliate of our manager with a total UPB of $303 million. These acquisitions consisted of 23 loans with an aggregate UPB of $289 million and 18 participations related to loans already owned by LFT with a total combined UPB of $14.5 million. 82% of these acquisitions during the quarter were secured by multifamily assets, 17% were secured by self-storage assets, and 1% were secured by office. The Q2 acquisitions had a weighted average spread to LIBOR of 379 basis points, a weighted average LIBOR floor of 113 basis points, and a weighted average LPV at origination of 67.2%. We experienced $175.8 million of loan payoffs during the quarter, and at quarter end, our total loan portfolio had outstanding principal balance of $611.5 million. The portfolio consists of 44 loans with an average loan size of $14 million, which provides for significant asset diversity. Our portfolio has weighted average spread to LIBOR of 366 basis points, 98% of the loans in our portfolio have a LIBOR floor above the current spot LIBOR rate with weighted average floor of 132 basis points. Our overall loan portfolio at quarter end was 85% multifamily, down slightly from prior quarters due primarily to our investment this quarter in self-storage. Self-storage represents 9% of our portfolio at quarter end compared to 1% in Q1. Meanwhile, our retail exposure decreased from 7% to 4% of the portfolio. We believe that generally self-storage and industrial property types provide the least volatility in performance outside of multifamily. Typically, our self-storage debt investments are related to top national operators and are in markets with per capita existing supply below the historical national average of seven square feet per capita. Furthermore, we focus on moderately leveraged assets as reflected by the weighted average LTV of 61% on our self-storage portfolio. Despite this increase in self-storage investments, due to our manager's strong focus in multifamily, we continue to anticipate that the majority of our loan activity will be related to multifamily assets. However, we will look to supplement our multifamily portfolio with quality investments and other asset types that can offer a strong return profile relative to multifamily. Turning to the recent CLO issuance, in aggregate, approximately $834 million in investment grade related notes were issued and sold to institutional investors, while LFT retained subordinated interest in the CLO of approximately $166 million. This represents an extremely attractive advance rate of 83.375%, which compares favorably to an average advance rate of 78.3% on LFT's prior CLOs as of March 31st. The offered notes had an initial weighted average spread of 143 basis points over one month LIBOR, excluding fees and transaction costs, which is very consistent with the costs of our prior CLOs. The new CLO has a 30-month reinvestment period running through December of 2023 that allows principal proceeds from repayments of mortgage assets to be reinvested. In addition, the initial collateral for the CLO includes approximately $314 million in of RAMP, which will be used to acquire additional loans or participations over the first 180 days. Just as a reminder, we do not currently utilize repo or warehouse facility financing at LFT, and therefore we are not subject to margin calls on any of our assets from repo or warehouse lenders. Subsequent to quarter end, on July 29th, the company acquired an additional $250 million of multifamily loans from an affiliate of our manager at a weighted average interest rate of LIBOR plus 337 basis points and a weighted average LIBOR floor of 17 basis points. These incremental acquisitions have allowed us to deploy a significant portion of the capital we raised during the quarter through our preferred offering in CLO. In general, market confidence and an economic recovery from the COVID environment has positively impacted bar demand for bridge loans during the year. With these improved market dynamics and increase in our pipeline, we feel positive about our investment opportunities. In the short term, we anticipate deploying the proceeds from our recent capital raises over the remainder of 2021 and are confident in our ability to keep our capital fully deployed ongoing. With that, I'll pass the call back to Jim.

Thank you, Mike. As I mentioned earlier, we feel We're making great progress in our business plan and our growth and are excited about the future of LFT. We look forward to updating you all on our progress and appreciate your time and interest today. With that, I'll ask the operator to open the call for 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're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2.

And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Christopher Nolan with Lattenburg-Thoutman.

Please go ahead.

Hi. Thanks for taking my call. Jim Briggs, the comments that you had on the decline in near-term earnings, Given the rollout of assets in third quarters to date, what would be the catalyst for that decline?

The decline in the second quarter earnings? I'm sorry, Chris, just to be clear on that.

Oh, yeah. No, I thought he was commenting that in the near term, coming quarters, we could see a decline in earnings.

Yeah, sorry, I was on mute. In my comments, I just mentioned that there is still capital to be deployed, and as a result of that, we could see a drag.

Okay. And then I guess two follow-up questions. One is on the addition of self-storage. Do you guys anticipate this becoming a significant issue part of your strategy above where it's currently at, or just sort of stay at current levels?

No, so I wouldn't describe it as a significant component. What I would say is, you know, our floating rate bridge program, since, you know, this management team has been executing that platform, which predates our taking over the management of LFT, we've always had a multifamily and housing focus. So 80, 90%, maybe a touch under 80 in certain periods. And that's generally been the way that we viewed the business going forward at LFT. And so self-storage is not something that, it's something we've continued to put on our own balance sheet as, you know, just for yields and an attractive product that we feel like we know well. The size of LFT over the past, or just in general, but certainly since we've taken over management, has, you know, limited our ability to generally diversify. But I think, you know, as we stated, multifamily and housing in general is our bread and butter, and I would expect it to continue to be maintained at or about the current levels or more. This uptick is largely related to doing the equity offering, having a large portfolio of assets that we were able to immediately deploy capital that was raised by moving assets from the manager's balance sheet into the REIT at one time. So I think it perhaps looks a bit overstated because of that. But in general, I would expect it to be you know, stay at or below the levels, meaning the self storage and non, non multi, uh, asset classes to, you know, stay at that somewhere, somewhere South of, you know, 20, 30% or at the most.

And then your final question, final question. Please go ahead.

So I was just going to add to that. I mentioned that we did, um, substance and quarter end acquire 250 million of additional multifamily assets in July. And just to add to what Jim said, if you include those acquisitions as of the end of July, the portion of a portfolio investment in self-storage is now at 7%, or was at the end of July at 7%, and multifamily at 89%. So that was consistent with what Jim said. We'll supplement multifamily investments, but don't expect it to be significantly more than what you see.

Great. And final question, leverage ratio. What's the target leverage ratio going forward, and does that include the preferred stock in the equity part?

Yeah, so the – I mean, depending on what you want to look at for total leverage, but we would look at both total equity and common. We continue to believe that we're – For our size, our leverage is, we feel, appropriate because of the type of leverage that we utilize. You know, the non-recourse turned-out financing of the CLOs, the, you know, favorable and standard term loan, and even our preferred equity being perpetual with no put rights. In general, we think we're, overall, our leverage ratios are on the high side of market as we grow and continue, and we do expect to grow and continue to look and seek to raise new capital, the general expectation would be to look to raise capital that would, you know, help reduce that leverage ratio to, you know, more in line in the middle of the market.

Great. That's it for me. Thank you.

The next question will come from Chris Mueller with JMP Securities. Please go ahead.

Hey, thanks for taking the question and congrats on the two transactions this quarter. So I guess following up on that a little bit, can you guys talk about maybe what kind of loan capacity size you have following those two transactions or said a different way, what is the fully deployed portfolio size?

Well, the fully deployed portfolio size of, of loans would be, you know, a billion dollars, uh, just, just North. Um, yeah, so from a, from the standpoint of, uh, the, the only thing, not the only thing, but the, one of the, uh, benefits of the larger transaction allows us to execute larger deals. Um, and that's, that's largely, you know, due to just general diversification, number of loans. size, geographic concentration, et cetera. So we can deploy the capital in a wider range of assets, but it's roughly a billion dollars.

And then with repayments, they looked a little high this quarter. Was there anything behind that? And then do you have any thoughts of what repayments will look like for the rest of the year? Thank you.

And Priscilla can offer a few. I don't think there was any magic to what happened other than, you know, you had, you know, notwithstanding the Delta variant and some of the concerns around COVID that are elevated again, I think you probably had some bit of managers holding off a bit because of uncertainty and not wanting to, you know, to go into a permanent financing until they had more clarity on, you know, asset performance and overall economic health that might've facilitated some guys perhaps waiting a bit longer. But in general, I don't think Priscilla, you can offer your thoughts on this, but I don't, I don't think there was any particular catalyst to say, Hey, we need to prepay and get this refinanced. You know, people are concerned about rates, but we could probably go back and listen to these calls for the last couple of years. And I've generally said, you know, people are concerned about rising rates many of those quarters. So I'm not sure that's a, that's a, that's a real true narrative, but me and Priscilla, if you have other thoughts there.

Sure. I would say the prepayment rate, to Jim's point, is fairly consistent. I will note that perhaps one factor to consider is there was a bit of a, obviously last year with COVID, there wasn't much activity on either the acquisition or financing side. And so there might have been a little bit of a delay, if you will, prepayment rate. level from the perspective of there were prepayments that probably should have happened last year, but were pushed off a little bit. So there was a bit of that, but I would not say in the material amount.

Great. Thanks for taking the questions.

Thank you. Again, if you have a question, please press star, then 1. This will conclude our question and answer session.

I would like to turn the conference back over to James Flynn for any closing remarks. Please go ahead, sir.

Thank you. I just want to thank everyone for your continued interest in LFT. I look forward to speaking again next quarter. And please reach out if you have any other questions, and we'll talk to you soon. Thanks all.

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