Lument Finance Trust, Inc.

Good morning, and thank you for joining the Lumen Finance Trust fourth quarter 2022 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 2022 financial results. With me on the call today are James Flynn, CEO, Michael Larson, President, and James Briggs, CFO. On Thursday, 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 Act of 1934. When used in this conference, words such as outlook, evaluate, indicate, believes, will, anticipates, expects, intends, and other 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 are discussed in the company's reports filed with the SEC, including its reports on Form 8K, 10Q, and 10K, and in particular, the risk factor section of our 10K. 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 statements. Furthermore, certain non-GAAP financial measures will be discussed on this 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 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. Good morning, everyone. Welcome to the Lumen Finance Trust earnings call for the fourth quarter of 2022. Thank you for joining. I'd like to first begin by addressing the economic environment. Obviously, more news today that we're all paying attention to. But the multifamily market has continued to experience a transition as lenders and investors react to the higher interest rates. the economic uncertainties, the capital markets, and overall volatility. Investment activity has declined relative to 12 months ago. Buyers and sellers work to reassess financing costs and find a new normal for levels of asset valuations and financing structures. We've seen, just anecdotally, 17% year-over-year decline in transaction volume. on the investment sales side quarter over quarter. But if you go back to the fourth quarter, you saw almost 70% decline. So you've seen, obviously, a significant decline in just market activity. However, despite the lending recessionary indicators increasing and potential negative impacts of the ongoing banking crisis, the employment market remains relatively strong and supportive of continued rent growth. for many multifamily assets, although we do see a slower rate than we've seen over the previous two years. And while the margin may be thinning, we do continue to expect rents to generally outpace expenses in most of our markets and believe the credit quality of the middle market workforce housing asset remains attractive. That middle market housing supply demand Dynamics, demographics, and long-term rent growth trends do create and continue to create an attractive investment opportunity for shareholders over the long term. Our multifamily investment portfolio has performed well. While we did book an additional unrealized loss reserve against our sole office loan this quarter, which we ultimately realized last month and which we'll discuss later during the call, the remainder of our book continues to perform well overall. More specifically within the bridge lending market, lending standards have continued to tighten. Pricing on new loans has increased industry-wide over the past several quarters. We do expect the average spread on LST's investment portfolio to continue to increase. As the portfolio grows, we experience payoffs and are able to reinvest in our existing CLO. With all that backdrop, the broader capital markets have remained extremely volatile. Conditions in the CRE CLO market very recently showed signs of encouraging trends relative to where they've been. However, the market for new issuances has become significantly more uncertain over just these past few weeks due to the developments in the banking industry. In order to continue to grow our portfolio on a levered basis, to fully deploy our capital and to take advantage of our managers' origination capabilities, we remain actively focused on executing a loan financing transaction to leverage newly acquired loans. We've historically utilized the CRE CLO market to finance our investments and continue to believe that that market provides an attractive financing source due to the favorable leverage as well as non-recourse, non-market-to-market features. And while we're prepared to execute a CLO quickly, the extent the market conditions change and improve we are actively exploring alternative financing options including private transactions note on note financings ano structures and warehouse facilities with regard to our dividend on march 16th we declared a quarterly common dividend for the first quarter of 2023 of six cents per share this is in line with our dividend level over the prior four quarters We continue to anticipate that we will have the ability to increase our dividend at such a time that we're able to execute a loan financing transaction. We continue to focus on deploying our capital into the CRE debt investments with a focus on multifamily. As you know, our manager is one of the nation's largest capital providers in the multifamily and feeder's housing space, executing over $10 billion in total transaction volume in calendar year 2022, servicing a $48 billion portfolio, and employing approximately 600 employees in over 30 offices nationwide. That scale and expertise of the manager's broad platform will continue to benefit the investors of LFT. With that, I'd like to turn the call over to Jim Briggs, who will provide some details on our financial results.

Jim? Thank you, Jim, and good morning, everyone. On Thursday 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 through eight of the presentation, you will find key updates and an earnings summary for the quarter. The fourth quarter of 22, we reported net income to common stockholders of approximately $880,000, or two cents per share. We also reported distributable earnings of approximately $3.3 million, or $0.06 per share. This compares favorably to the distributable earnings of $1.7 million, or $0.03 per share, in the prior quarter. There are a few items I'd like to highlight with regards to our Q4 P&L. Beginning with net interest income, our Q4 net interest income was $6.9 million, compared to $5.5 million in Q3 of 22. which represents a significant 26% increase quarter over quarter. This increase was primarily driven by higher LIBOR and SOFR rates. During Q4, LIBOR averaged 3.88% versus an average of 2.46% during Q3. Short-term interest rates continue to increase, which we expect will continue to benefit LFT's earning profile over the coming quarters. During Q4, we experienced 45 million of loan payoffs, which represents an increase relative to 34 million of loan payoffs during Q3. 45 million of payoffs experienced during the quarter represents a 17% annualized payoff rate. While this payoff rate is below our long-term historical averages, we expect to continue experiencing similar payoff speeds over the coming quarters due to persistent interest rate volatility and economic uncertainty. The primary difference between our distributable and reported net income during Q4 was a $2.4 million provision for loan loss. In Q4 of this year, we recorded a provision for loan loss of $2.4 million or $0.05 per share on the $10.3 million loan collateralized by an office property in Chicago, which we have discussed in prior quarters. The loan was originated in July of 2018. And as of year end was LFT's only office property investment. We had previously entered into a forbearance agreement with the borrower, extending the maturity date to December of this past year to allow the borrower more time to market and sell the property. However, the borrower was unable to execute a sale in that timeframe. Subsequent to year end on February 27th, the property was ultimately sold via auction to for $6 million and we accepted a discounted payoff from the borrower in that amount. Having established the total of allowance of 4.3 million during the course of 2022 on that loan, we will not incur any further negative impact to book value or gap EPS in 23 as a result of the discounted payoff we accepted. While we expect no impact to book value or gap EPS from this asset, and disposition in 2023, we do expect a $4.2 million negative impact to distributable earnings in Q1, reflecting the realized loss as unrecoverable. During the period ended December 31st, we identified one additional loan collateralized by a multifamily property and with an unpaid principal balance of 12.8 million as impaired due to monetary default. And we individually evaluated that asset No reserve has been recorded based on an analysis of the underlying collateral. This loan is on non-accrual status, and we are pursuing all remedies on this asset. As Jim mentioned in his opening remarks, the remainder of our loan portfolio continues to perform, and other than the provision taken this quarter on the office loan, which is now resolved, we have not taken any other loss provisions. Moving on to expenses, our total expenses were $2.5 million during Q4, which represents a decline relative to total expense 2.7 million during Q3. As of December 31st, the company's total book equity was approximately 243 million. Total common book value was approximately 183 million, or $3.50 per share. As I've discussed in prior quarters, I would like to remind everyone that as a smaller reporting company, as defined by the SEC, as of December 31st and through this 10K, we have not yet adopted ASC 2016-13, commonly referred to as CECL, Recurring Expected Credit Losses, which is a comprehensive gap amendment of how to recognize credit losses on financial instruments. Our recently filed financial statements were prepared on an incurred loss model basis. We disclosed in the 10-K upon adoption of CECL on January 1, 2023 of this year. We expect that based on current expectations of future economic conditions, our general allowance for credit losses on loans held for investment, including future loan funding commitments, will be between $3 million and $4 million, worth 30 basis points and 40 basis points of the company's total loan commitment balance of $1.1 million as of December 31st. This implementation impact will be recorded as an adjustment to 2023's opening accumulated earnings balance. And I'll turn the call over to Mike Larson, who will provide details on our portfolio composition and investment activity.

Thank you, Jim. Good morning, everyone. As Jim Flynn touched on earlier, the broader economic conditions, which have continued to be volatile and uncertain, have driven a decline in new acquisition activity. And it also expressed the number of bridge loan opportunities that support the current in-place costs of financing that exist in the market. At the same time, we have seen and expect payoff speeds to temper in the near term, reducing our capacity for new investments relative to previous quarters and years. We anticipate that trend to continue throughout 2023, while interest rate increases moderate and the general real estate markets reset to new higher interest rate environment. During Q4, LFT directly originated five new investments with a total unpaid principal balance of $75.6 million. Four of these new investments were supported by senior housing assets, and one was secured by multifamily assets. The new loans acquired this previous period were indexed to 30-day terms SOFR and had a weighted average spread of 398 basis points. That level represents a meaningful increase relative to the current portfolio weighted average spread of 343 basis points. New acquisitions had a weighted average index rate floor of 82 basis points, also an increase relative to our average of our portfolio of 37 basis points. The acquired loans had a weighted average LTV at origination of 55%, which is, we believe, a attractive leverage point and is below our portfolio average LTV of 71.5%. As mentioned, we experienced $45 million of loan payoffs during the quarter, and at quarter end, our total loan portfolio had an outstanding principal balance of $1.1 billion. That's a 3% increase in portfolio size quarter over quarter and a 7% increase relative to the fourth quarter of 2021. The portfolio consists of 71 loans with an average loan size of $15 million, which continues to provide for significant asset diversity. Our portfolio at quarter end was 90% multifamily. It's important to note our exposure to retail and office continue to remain very low at only 2% of our total at year end and 1% after the a payoff of the last office property in portfolio. So again, currently we have no office exposure in the portfolio. Due to our manager's strong focus in multifamily and seniors housing, we continue to anticipate the majority of our loan activity will be related to those asset classes. Our investment return profile has a strong positive correlation with rising interest rates. We have included a rate sensitivity table on page 11 of our supplemental earnings presentation. And overall, we expect LFT to benefit from elevated short-term interest rates as the Fed continues to battle inflationary pressures. Since quarter end, the one-month term SOFR rate has increased from 4.39% to 4.76% today. While there is currently uncertainty around further increases in short-term rates, We anticipate a continued positive P&L impact from elevated rates in the short term at LFT. As of 12-31, our loan portfolio was financed with one series CELO securitization that has a weighted average spread of 143 basis points over one month LIBOR and an advance rate of 83.375%. CELO has a reinvestment period running through December of 2023 that allows principal proceeds from repayments of assets to be reinvested in qualified replacement assets subject to various conditions.

And with that, I'll pass the call back to Jim for some closing remarks. Thanks, Mike.

Well, we look forward to continuing to update on our progress. Obviously, things are changing on a daily basis and look forward to the more stability in the market. But with that, I'd like to open it up to questions from the participants.

We will now begin the question and answer session. And 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. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Stephen Laws from Raymond James. Please go ahead. Hi, good morning.

I guess, Jim Briggs, I'll start. Appreciate all the color on the office loans. That answered a lot of my questions from the modeling, so appreciate that. Then with the CECL implementation, I just want to make sure I'm clear there. The $3 million to $4 million impact Will that run through the income statement and then be added back in Q1, or only any change versus that January 1 adjustment that would run through the income statement?

Stephen, it will be just a change from that number. So we're anticipating our opening adjustment to equity. Retained earnings with no P&L on PAC will be within that range, and then it will be any change from that in the quarter because of Moves in the portfolio, moves in the economic forecast, and other factors that go into the calculation. Great. That makes sense.

I just wanted to make sure I was understanding that correctly. To move maybe to the originations, you know, the four loans, I think, and investments with health care, can you talk about, you know, what you're seeing there that makes an attractive relative multifamily? Was this just a unique quarter and maybe too small of a sample size to read anything into? I know the deck, you know, obviously clearly states multifamily will remain the primary focus. And then maybe as a follow-up on the new investment activity, LIBOR floors, those were under 100 bps, and a little surprised they're that low. Are you not focused on that, more focused on maybe the 55 LTV metric you put out? Or can you talk about the things you're pushing for in new loans and kind of how you prioritize those things?

Sure. I mean, I'll take first on the seniors housing piece of it. Just a couple points there. We've discussed in the past, Our manager is one of the largest providers of financing in the seniors housing healthcare space, and so we do see significant opportunities in that space, although we are focused on multifamily investments. We recently did see some attractive opportunities. You said lower leveraged and made those investments last quarter. The dynamics of healthcare properties tend to have much higher debt yields and dynamics that support bridge financing in this market. And these assets we thought were a good opportunity for LST to continue to grow the portfolio despite the decline in transaction activity that we've seen. I don't expect a significant increase in seniors' housing and expect our continued focus to be on multifamily.

Great. And one last one, if I might. A quick one. Any seasonal expenses to think about if you want a pilot or the CLO that you're looking to get done to model in? I had a little bit of trouble. Can you repeat that question? Sure. Any seasonality we need to think about with expenses in Q1 related to year-end SEC filings or auditing or potentially with the CLO deal that's in the market that we should include in our model from an operating standpoint?

Jim Briggs, you can speak to the audit. I don't believe anything that's different than what we've seen in past years? No, I think that's correct.

Great. I appreciate the comments this morning.

Again, if you have a question, please press star, then one. Our next question comes from Jason Stewart from Jones Trading. Please go ahead.

Good morning, guys. Thank you. On the multi-side, what kind of transition rates are you seeing from class A to B to C, if you can talk to that and maybe how that impacts your portfolio.

When you say transition rates, you mean available investment opportunities?

Well, I'm looking actually for color on the underlying resident movement. So who's going from class A to B to C? Does that improve occupancy, physical, etc.? ?

Yeah, I think, I mean, look, you obviously have to be, you have to look at each market and micro market in general. Historically, we found that there's less volatility in occupancy at the, you know, what we've largely described as workforce housing, which, you know, BEC, and even if you slip into the affordable space, there's The primary reason for that is the supply-demand demographics or balance is far out of whack. And so I don't know that we're there yet to fully identify a trend, but typically in a time of distress, whether it's recessionary or just kind of economic downturn, that you're more likely to see more people looking for more affordable housing than where they currently live than going the other way so i don't i do i would continue to expect um and you also have yeah you know we do have um new builds coming online in certain markets and they're going to be newer and nicer and so they'll probably uh or in many cases will will lease up uh but that may be to the detriment of their um you know the the comp set in in the area but in general um you know the occupancy levels at those mid and lower level apartments um which is which is obviously the the majority of where we we operate uh is generally improves or remains more stable is probably a better word uh in times of distress yeah

I would expect that too. Okay, that's helpful. And then how would you characterize the takeout financing for transitional projects right now? I mean, Fannie, Dust, Freddie K seems to be a little bit illiquid. How would you characterize the ability to get out of a project?

I think that what you just said is true of the agencies. They certainly are. We've certainly seen an uptick of a lot of folks looking at more deals and i think and and there's also again very recent history you know past couple of months um more interest expectation on borrower sides of coming in with cash to put put long-term financing on um the banking crisis uh that's that's ongoing uh the impact and the impact on community banks and regionals um i think is only going to further exacerbate that problem that you described around takeout financing. I think, you know, from our standpoint and what we've seen in general, you look at the trends in the space, you look at the long-term prognosis for multifamily, and, you know, it's still, from our perspective, a long-term attractive asset. And I think owners feel the same way, certainly a naturally optimistic group. that there's a bit more acceptance of trying to, perhaps accepting that they may need to give up some of their equity or potential equity gains in order to get lock-in reasonable and attractive long-term financing. And that can be in the form of a cash-in if they're well capitalized or able to raise capital fairly easy. It can also be at the common level. I think we've seen a significant uptick in the interest for preferred equity and or MES throughout the industry. We've seen deals getting done, but I know that there's just a lot more borrowers that are looking to bring in a new partner. execute the business plan and hold the asset maybe longer than they originally planned, but with new equity and longer-term debt. I do think we're going to need to see a lot of that for most bridge loans. You know, an 80 or 85, even an 80 LTV bridge loan is not going to get an 80 LTV 10-year loan. And so there's value protection there, but they are going to need, you know, cash infusion in either the form of common or some other subordinate capital. The good news is, from a borrower standpoint, is there's a lot of that capital that's either out there being raised or lenders and others expressing interest to do so.

Got it. That's helpful. Thank you.

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

I just want to thank everyone for joining. I know it's another hectic morning. We will continue to be in touch and look forward to speaking to you all again soon. Thank you.

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