Lument Finance Trust, Inc.

Good morning, and thank you for joining the Lumen Finance Trust third quarter 2023 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 floor over to Andrew Tsang 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 third quarter 2023 financial results. With me on the call today are James Flynn, CEO, James Briggs, CFO, James Henson, President, and Zachary Halpern, Senior Director of Portfolio Management. Yesterday, on Monday, November the 13th, we filed our 10Q with the SEC and issued a press release to provide details on our third quarter results. We also provided a supplemental earnings presentation, which can be found on our website. Before handing the call over to Jim Flynn, I'd like to remind everyone that certain statements made during the course of this call are not based on historical information and they constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this conference call, words like outlook, evaluate, indicate, believes, will, anticipates, expects, contends, 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 Forms 8-K, 10-Q, and 10-K, and in particular the risk factors section of our Form 10-K. It is not possible to predict or identify all such risks. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Presentation of this information is not intended to be considered in isolation, nor is a substitute for financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures, as the most comparable measures compared in accordance with GAAP, can be accessed through our filings with the SEC at www.sec.gov. For the third quarter, we reported GAAP net income of $0.10 per share, while distributable earnings were $0.11 per share. In October, we paid a dividend of $0.07 per share with respect to the third quarter, which represented approximately a 17% quarter-over-quarter increase. I will now turn over the call to Jim Flynn. Please go ahead.

Thank you, Andrew. Good morning, everyone. Welcome to the Lumen Finance Trust earnings call for the third quarter of 2023. We appreciate everyone joining today. The macroeconomic environment continues to be a challenging one. A mild recession beginning in the first half of 2024 remains a possible outcome as higher for longer rate environment seems to be the consensus economic forecast. Given the surprising resiliency of the labor market, consumption continues to outpace incomes and government spending and interest cost concerns. As we await the impact of the recent and dramatic monetary policy tightening to fully work its way through the system, we are also faced with heightened geopolitical uncertainty, further muddling the near-term outlook. Given the interest rate volatility, multifamily and other commercial real estate property types continue to trade thinly. Overall, U.S. commercial real estate investment sales volume was down greater than 50% year-over-year in Q3. Despite deceleration of rent growth and widening of year-over-year cap rates, multifamily continues to be the preferred sector and is supported by strong fundamentals. While deliveries are elevated in certain markets this year and next, Muted new construction starts suggest limited supply in the medium term, which is supportive of higher asset values as we move forward. Demand for multifamily continues to be driven by historic homeownership affordability gap, with prices of single-family homes remaining high, and residential mortgage rates currently north of 7%. Given these positive signs in the long term, LFT remains committed to its investment roots in seeking middle market multifamily investment opportunities that are accretive to the earnings and long-term shareholder value. The CRE CLO market continues to see significant dysfunction, with only two managed CRE CLO transactions priced during the third quarter and year-to-date. Issuance volumes through October are down 66% year-over-year from an already the press prior year. Given the uncertainty in the capital markets, we are proud to have successfully executed on July 12th, a 386 million floating rate mortgage portfolio financing transaction that we will subsequently reference as LMF 2023-1. In connection with LMF 2023-1 transaction, 270 million of an investment grade rated senior secured floating rate loan was placed with a private lender and approximately 47 million of investment grade notes were issued and sold to an affiliate of our external manager. LFT retained 67 million of subordinate notes in that transaction. The outstanding liabilities of this financing transaction have an initial weighted average spread of 314 basis points over 30-day term SOFR, excluding fees and transaction costs. The initial collateral pool consisted of 25 first lien floating rate mortgage loans secured by 32 multifamily properties located across the United States. The majority of the collateral was acquired from an affiliate of the manager at an aggregate discount to par of approximately 1.5%. The weighted average spread of the initial collateral was approximately 365 basis points over 30-day term SOFR, which we estimate works out to an effective spread on the initial collateral pool north of 425 basis points. LMF 2023-1 provides for a 24-month reinvestment period that allows principal proceeds from repayments of the mortgage assets to be reinvested in qualified replacement mortgage assets subject to certain conditions. Confirmation of this financing allowed the company to increase its investment capacity to approximately $1.4 billion at a relatively attractive incremental cost of capital. With the closing of LMF 2023-1, Coupled with our CRE CILO debt previously issued in 2021 and outstanding corporate term loan which matures in 2026, the company currently maintains an attractively priced and long-dated liabilities profile that positions us well as we enter an uncertain part of the market cycle. LLT's investment strategy of acquiring floating rate mortgage asset positions positions it well for a higher-for-longer rate environment. We believe the company consistently differentiates itself from its peer group through its continued focus on middle market multifamily credit opportunities, its culture of active asset management, and its strong sponsorship from the broader Oryx platform. With that, I'd like to turn the call over to Jim Briggs, who will provide us details on our financial results. Jim?

Thank you, Jim, and good morning, everyone. Last evening, we filed our quarterly report on Form 10Q and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. Supplemental investor presentation has been uploaded to the webcast as well for your reference. On pages four through seven of the presentation, you'll find key updates and an earnings summary for the quarter. For the third quarter of 23, we reported net income to common stockholders of approximately 5.2 million or 10 cents per share. There are a few items I'd like to highlight with regard to third quarter P&L. Our Q3 net interest income was $9.5 million compared to $7.5 million in Q2, primarily as a result of the growth of our loan portfolio facilitated through the execution of the LMF 2023-1 financing transaction in July. SOFR increased 23 basis points during the quarter from 5.09% to 5.32% driving an increase in the interest income on our portfolio and excess of the increase in the cost of our floating rate liabilities. Exit fees and other prepayment-related income were relatively flat sequentially, despite payoffs being higher than prior quarter due to a larger portion of the multifamily payoffs this quarter being refinanced with agency debt provided by an affiliate of the manager. Note that in such situations, a portion of the manager's expense reimbursements are waived pursuant to the terms of the management agreement. Our total operating expenses were $2.4 million during Q3 versus $4.4 million in Q2. This quarter-over-quarter decrease was driven primarily by the $1.7 million, or $0.03 per share, of deal costs we expensed in Q2, which had been incurred in pursuit of executing a broadly marketed CRE-CLO securitization transaction, which we ultimately abandoned in Q2 in lieu of the more attractive LMF 2023-1 private financing transaction. For Q3, we reported distributable earnings of approximately $6 million or 11 cents per share. The primary difference between reported net income and distributable earnings was the approximate 800,000 net increase to CECL general reserves in the quarter, primarily due to the increase in the overall size of the floating rate loan portfolio as well as changes in the macroeconomic forecast in the period. As a non-cash unrealized item, these charges are adjusted out for purposes of calculating distributable earnings. We did not take any asset specific provisions in Q3. As of September 30th, the company's total equity was approximately 241 million. Total common book value was approximately 180 million or $3.46 per share. of $0.03 per share from Q2. We ended the third quarter with an unrestricted cash balance of $43 million. We also had an additional $30 million of aggregate reinvestment capacity through our two secured financing. We'll now turn the call over to Jim Henson to provide details on the company's investment activity during the quarter and portfolio performance. Jim.

Pardon me, this is the conference operator.

Mr. Hempston, is it possible your phone is on mute?

Yes, thank you. Thank you, Jim Briggs, and thank you. I will now provide a brief summary of our recent activity within our investment portfolio. During the third quarter, we experienced a net $341 million increase in our loan portfolio after accounting for $111 million of loan payoffs. The $111 million of loan payoffs experienced during the quarter represent approximately a 33% annualized payoff rate, which is relatively in line with the long-term historical averages and our short-term expectations. Of the $452 million of loan investments acquired or funded during the quarter, 99% were collateralized by multifamily properties. Loans acquired during the quarter from an affiliate of the manager were acquired at an aggregate discount to par of $7.1 million. As of September 30th, our portfolio consisted of 87 floating rate loans with an aggregate unpaid principal balance of approximately $1.4 billion, of which 93% was collateralized by multifamily properties. 100% of our floating rate portfolio is indexed to one month SOFR. Our investment portfolio performed well. We ended the third quarter with 75% of the portfolio risk-rated a three or better, and we have maintained a weighted average risk rating of 3.4 quarter over quarter. Several offsetting factors impacted the average risk rating for the quarter. On one hand, the average risk rating would have shifted toward improvement during the quarter due to the company acquiring four new two-rated loan investments with an aggregate unpaid principal balance of $64 million. and two existing loan investments totaling $31 million of unpaid principal balance moving to a two rating during the quarter due to improved property performance metrics. In addition, several assets migrated from a three to a four rating, and two loan assets migrated from a four to a five rating. We had three loan investments, each collateralized by a multifamily property, which were rated a five for the third quarter. These loans with an aggregate unpaid principal balance of $69 million are currently considered collateral dependent due to the actual or expected monetary default. One of these three loans we have discussed in prior quarters and we continue to pursue all available remedies with regard to that loan. After conducting our analysis of the underlying collateral, we have concluded we have not recorded any specific reserves with respect to these investments. We continue to proactively monitor the health of our portfolio, and we rely on the depth and breadth of our managers' capabilities to drive positive asset management outcomes while protecting shareholder value. With that, I will pass it back to Jim Flynn for some closing remarks.

Thank you, Jim Henson. Appreciate everyone's time and interest. I want to open the call up for questions. I know there's a few already in the queue.

Ladies and gentlemen, at this time, we'll begin that question and answer session. To join the question queue, you may press star and then one using a touchscreen telephone. To withdraw your questions, you may press star and two. If you are using a speakerphone, we do ask that you please pick up your handset prior to pressing the key to ensure the best sound quality. Once again, that is star and then one to join the question queue. Our first question today comes from Steven Loss from Raymond James. Please go ahead with your question.

Hi, good morning. Hey, good morning, guys. Let's start with the three multifamily loans. Can you give us some details, kind of where the, as you've talked about one before, but where are they located? Are they with the same borrower or different sponsors there? And, you know, what's the timeline on kind of resolving that and recycling capital and performing that?

So I'll let Zach Halperin talk on the details. They're all different sponsors, all different locations, and in different stages of underperformance. But as Jim pointed out, we still feel comfortable that we're going to be repaid on the collateral, but we're working with with the borrower, they all have different, um, issues. Um, and so I'll let Zach give you, give you the high level of kind of generally where they are, but, um, you know, one, one is primarily a partnership dispute. Um, you know, one is behind his business plan and one is, um, you know, had significant issues at the, at the physical property and is, is working through, um, you know, proceeds on insurance, et cetera. Zach, you want to go ahead and give a high level?

Sure. So the asset that we've been talking about for the last three quarters is in Ohio. The asset, there's another asset in Virginia. That is the one that's in partnership dispute. And then there's an asset in Florida that's behind on its business plan. When we consider all three assets and look at them and, you know, have sought, you know, information on that and site visits, et cetera, we find that with the exception of the first asset, which Mr. Hansen mentioned, we're pursuing legal remedies on and also do not expect a loss. While there is some monetary issues, the loan appears to be lower than the value at present and leaves the borrower slash sponsors with incentive to secure these and work towards resolution and therefore not expecting losses at present.

And you had asked Steven on the time. One, there are payments being made. in a variety of ways, paying down principal, paying interest late, those kinds of things. The timeline is, as you know, there's some uncertainty to it all, but we're certainly expecting these to be resolved in the next couple of quarters is kind of how I'm looking at it, at least one or two of them and maybe all three. But, you know, for better or worse, things sometimes seem to take longer. You know, for example, the partnership dispute is really, it's impacting us as lender, but it's an issue between the two owners, and, you know, they have to settle their own dispute, and then I think we would be ready to move forward, likely through a sale or whatever they decide to do. So, we're pursuing our remedies to push them to get to their conclusions. So some of that's an example of just, you know, working through the legal process. Um, but hopefully a first half of 24 events. Um, but you know, it could, it could be longer.

Sure. It sounds like it's unique issues that each asset, not anything that's correct. It's not a, yeah.

Um, the other thing I've written is that, um, These two assets are within the securitization whose reinvestment period is ending. There's not too much we can do near term anyways, even if these pay off to redeploy capital. We're going to have to deal with that securitization in probably late 2024. So it's not like we're losing investment capacity.

Understood. And then did they go on a non-accrual end of quarter? Were they in interest income for the full 3Q or did some of them only contribute for partial or none of the quarter?

We reversed out when we put it non-accrual around 300 grand. As Jim mentioned, we talk in our filing about them being on a cash basis. So we are seeing some payments there, which will reflect an income as we get it. It was around $300,000 of income that got reversed in the quarter. Helpful. Great.

Appreciate your time this morning. Thank you.

Our next question comes from Steve Delaney from JMP Securities. Please go ahead with your question.

Thanks. Well, good morning, Jim, Jim, and Jim. Jim Flynn. The portfolio at $1.3 billion, about 4.5% debt to equity. Do you consider Lumen's portfolio to be fully invested currently based on your capital base? Thanks.

Yeah, thanks, Steve. Good to hear from you. We have... The answer is yes. It's around 1.4 is the total capacity, give or take. Obviously, we want some cash. We have a couple assets that we've discussed. But generally speaking, it's upwards of 1.3 and close to 1.4. We're obviously where we have... you know, as loans work themselves out and things like that, we've generally kind of made the decision to maintain the liquidity, the elevated liquidity for, you know, for obvious reasons. But that's the kind of max of our portfolio today. As we've discussed many times, obviously we want to, you know, think about growth, but right now it's really focused on our portfolio, asset quality, working with sponsors, making sure that we're position to take advantage of the market as it improves down the road here.

That's helpful. I mean, we really are in a market, it would seem, would emphasize quality over quantity at this point. You can kind of wait and see. So the net interest income that you had, $9.5 million, it was, I think, $7.5 million in the prior quarter. I realize with repayments, you get acceleration. Is there anything in that $9.5 million that you would point out to be materially large one-time accrual of revenue that you had on either discount or deferred fees that you had on the books?

Jim, you want to go ahead?

Yeah, no, I wouldn't say there's anything one-timer in there. As we talked about, the economics around prepayment and fees there, we're relatively flat quarter on quarter. Some of that is coming through a reduction in expense reimbursements, but I don't consider there to be anything material in there, Steve.

Okay, great. And just one final point. The $7.1 million that you pointed out, this counts specifically to LMF 2023-1. Should we look at that? I don't know if those loans were already originated, but would a three-year average life, would that be a reasonable approach to accreting that money into the net interest income?

Yeah, I think that's reasonable, Steve.

Okay. Well, great quarter, and good job on the big financing, and we'll look forward to fourth quarter. Thank you very much. Thanks, Steve.

Our next question comes from Matthew Erdner from Jones Training. Please go ahead with your question.

Hey, good morning, guys. Thanks for taking the question. So could you just talk a little bit about what the opportunities you're seeing out there currently? I know that you guys focus on multifamily, you know, but can I just get an idea of what you guys are looking at at the moment and just the health of the pipeline? Thanks.

Sure. Well, look, I mean, the opportunities are – are um less than they've been in in prior quarters as as we've discussed just in terms of transaction volume being so significantly down so assets aren't aren't trading hands so so that's you know that opportunity has significantly declined um but so has so have lenders um and and lenders that are um either can or are willing to um to make new loans. So when we have seen assets come in, you know, we are looking at, you know, generally speaking, you know, more conservative looking underwriting, lower leverage, you know, high quality sponsors. It does have an impact, you know, I think with rates being so high, spreads have kind of stabilized around, you know, 4%, but you've seen a lot of, you know, pressure on that. I'm sorry, spreads at four, but I think you've seen a lot of pressure on that to, to be lower when you've gone with, you know, very low, low levered bridge loans and, and kind of pushing things down toward 3% for those high quality loans. I think you'll see lenders probably take a look at those deals and, and, and trade a little, um, spread for, for risk or, or lower risk. In terms of some of the things we've talked about in the past around subordinate debt opportunities around med financing, preferred equity, etc., there's a lot of market chatter around those particular products. There's a lot of lenders and people looking to participate in that market, including us, both at LFT and in our broader platform. The reality is that there's not a tremendous amount of deals that that works for today, given where the rates are expected to be for that product, you know, in the teens, mid-teens even. And it's hard to replace your, you know, prior debt capital if you're kind of refinancing something with a mid-single digit with a 2X on preferred. And so there's just – I think that we haven't yet seen kind of the – the dam break, so to speak, of transactions. I think as, you know, values, buyers and sellers kind of accept values, the spread between buyers and sellers narrows, I think we're going to see more opportunity for, you know, for new loans, for bridge-to-bridge transactions that are kind of moving, finishing off a prior strategy at a different cap stack, transitioning some of these assets that are being delivered off of construction loans to lease up bridge loans. And I think you'll see opportunities both on the bridge space. It's not going to be 2020 or 2019, but I do think we'll see some opportunity increase. And I also think that that other space um of of mezz capital as you start to see actual transactions assets changing hand that there'll be more opportunity there but we really need that transaction flow to pick up um and for that i think we need buyers and sellers to um you know accept where where values are and come to a agreement narrow gap and and then we'll see some of those opportunities um and as we noted you know we we retained some of the low investment grade rated bonds in our last transaction. And that was because it was an attractive spread. So there might be some opportunistic trades in the secondary market for some of these DLOs that are out there, but that's going to be very portfolio specific.

Got it. Thank you. That's good call there. I appreciate that. And then on the recent CLO, I don't know if you mentioned it or not, but is there a reinvestment period? And then if there is, when does that expire and how much of it is open at the moment? Thanks.

It's two years. And to be clear, I may have said CLO, but it's a financing transaction. It's not technically a CLO, just to clarify. But it is a very similar structure and it has a two-year reinvestment period.

Thank you.

Once again, if you would like to ask a question, please press star and then one. To withdraw your questions, you may press star and two. Our next question comes from Christopher Nolan from Ladenburg-Bauman. Please go ahead with your question.

Jim Briggs, just a clarification. Were there any non-recurring expense items in the quarter?

No, nothing unusual or one-timer. As I pointed out, we did have the big one-timer last quarter for the dead deal costs for a widely distributed public CLO. They were expensed in Q2, but nothing I would consider one-timer in the current quarter.

Great. And then I guess for just the panel in general, any change in non-accruals in fourth quarter to date?

Nothing to date. Yeah, no.

And then finally, looking through the deck and looking at the LTVs, which are roughly 75%, 80% or so, what sort of rent haircut are you applying when you evaluate those LTVs?

I don't think it's a – I mean, when we're looking at the assets, each one is an individual – evaluation meaning you know basically it's it's it's going to be a view of what are the in-place rents um most markets today have you know either somewhere in you know plus maybe two or three at the max to minus um you know the same the same level but but some markets and some markets are slightly different but in general um You know, we'd be looking at in-place rents, particularly if they're, you know, a lot of these assets are still renovating and still, you know, moving through their business plans, albeit obviously with whatever changes market conditions have warranted. And so there's real-time data on what does it look like for, you know, renting new units today.

So you're using the stated rent, right?

We're often using rent rules, right? So this is real information. I think that perhaps it's helpful to make a distinction between evaluating something like a CMBS bond in which you're looking at a tape of data provided to you by the service servers, looking at multifamily loans the way we're looking at it, which is asset management data, rent rules, information that's coming directly from the borrower that's not necessarily been passed through data tapes, et cetera. So it's a lot more boots on the ground than you might see versus what's in the CMBS conference.

Well, here's the issue I have. And I used to, just FYI, I used to run a portfolio of four rent-stabilized apartment buildings in New York City with 218 rent-stabilized units. And, you know, when you talk to bankers in this space, at least in New York City, they give a haircut to their reported rent roll of 25%. Simply because what your reported rent is could be different than what the actual rent is. Like, you get one month free or something like that. And... You know, if you're using what the stated rent rule is, doesn't that sort of over-inflate the value of the property on an LTB basis?

So let me just address that specifically. So when we look at rents, we are taking into account the leases, the concessions, right? We're not saying someone's giving two months free and then charging, you know, we're using what the real rent is, right? So concessions and things like that are not. And, but just also for context, um, you know, we we've seen, uh, or we'll see by the end of this month, every asset in our portfolio within the last, since June or July, uh, the summer. So over four months, we've gone out and visited every asset, um, with someone from our team and visiting with the sponsor. So to, to, to Zach's point, just, you know, these are transitional assets that had a business plan. They're not stabilized assets where a servicer pays someone to go out every two years to look at the asset. We are in contact with our sponsors on a regular basis, weekly, monthly, quarterly, whatever is appropriate for the given asset, and are physically out there seeing them. So there's a little bit more engagement there and real-time access to financial information than receiving to the point of if it's a large portfolio where you're receiving information secondhand and you're making some assumptions. We don't have to make those assumptions because we have the real data. There's not an assumption to make we know what it is.

I would layer on top of that a couple things. One is the LTGs that are reported on the earnings supplemental or LTGs at time of origination, which is denoted there. But the underwriting that is done in evaluating these assets is layering on all that nuance. We're not simply taking what the borrower gives us as our underwriting. Any nuance, whether it be free rent for a month or two or you know, issues on stabilization or issues on occupancy. That's all, you know, put into our underwriting and analysis as we're evaluating these loans, both at underwriting and an ongoing basis.

Okay. Thank you.

Ladies and gentlemen, with that, we'll close today's question and answer session as well as today's presentation. We thank everyone for joining today's conference call. You may now disconnect your lines.