Claros Mortgage Trust, Inc. (NYSE:CMTG) Q3 2023 Earnings Call Transcript

Claros Mortgage Trust, Inc. (NYSE:CMTG) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Hello, everyone and welcome to Claros Mortgage Trust Third Quarter 2023 Earnings Conference Call. My name is Nadia and I will be your conference facilitator today. [Operator Instructions] I would now like to hand over the call to Anh Huynh, Vice President of Investor Relations for Claros Mortgage Trust. Please proceed.

Anh Huynh: Thank you. I am joined by Richard Mack, Chief Executive Officer and Chairman of Claros Mortgage Trust; Mike McGillis, President and Director of Claros Mortgage Trust; and Jai Agarwal, CMTG’s Chief Financial Officer. We also have Kevin Cullinan, Executive Vice President, who leads MRECS Originations; and Priyanka Garg, Executive Vice President, who leads MRECS Portfolio and Asset Management. Prior to this call, we distributed CMTG’s earnings release and supplement. We encourage you to reference these documents in conjunction with the information presented on today’s call. If you have any questions, please contact me. I’d like to remind everyone that today’s call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will also be referring to certain non-GAAP financial measures on today’s call, such as distributable earnings, which we believe maybe important to investors to assess our operating performance. For reconciliations of non-GAAP measures to their nearest GAAP equivalent, please refer to the earnings supplement. I would now like to turn the call over to Richard.

Richard Mack: Thank you, Anh and thank you everyone for joining us for CMTG’s third quarter earnings call. At this time last year, the conversation among investors centered around the timing and depth of a 2023 recession, but it now looks like the U.S. may close this year without one. And while this appears to be positive news, there continues to be much capital market uncertainty as bond rates climb, especially in interest rate-sensitive industries. So it’s a confusing time, where good news about economic growth can be bad news for asset values and where headline economic data is subject to multiple interpretations. Add to this the elevated geopolitical risk unseen since the depths of the Cold War, punctuated by the ongoing Russia-Ukraine war and a renewed and rapidly evolving war in the Middle East, and you have the basis for persistent market volatility as investors struggle to price capital and underwrite future economic growth, corporate earnings and inflation.

Some in the professional investment space believe that we are nearing or at the end of interest rate hikes. Some are starting to discuss when, and not if, the Fed will begin to cut rates. However, it’s difficult for us to predict the trajectory of interest rates given the multitude of indicators that may influence Fed actions and the numerous and, in many cases, conflicting variables impacting inflation and economic growth. With this in mind, we at CMTG have been executing our business within the context of a higher-for-longer rate environment. And this is one of the main reasons we have been so proactive. We are managing our portfolio with a long-term investment perspective towards maximizing shareholder value, while acknowledging the commercial real estate industry’s challenges.

COVID-related demand shifts have been disruptive, particularly in the office sector, but perhaps not nearly as jarring as the COVID stimulus-induced inflation we are dealing with today and the subsequent higher interest rate environment. The combination of these 2 factors has resulted in capital markets dislocation that we continue to see throughout the real estate sector. Not surprisingly, amidst these headwinds, sales and transaction volumes have been significantly down over the past several quarters. However, outside of the office market, we have yet to observe many truly distressed trades. What we are seeing is transaction volume around select high-quality assets at only modestly lower values, in spite of the challenging environment. Turning past the economic climate, I’ll now add a few high-level remarks on the third quarter for CMTG.

We had an active and productive quarter overall, with portfolio management and strategic execution focused on liquidity and capital preservation. As mentioned on our last earnings call, we had anticipated significant loan repayments in our portfolio during the back half of the year. And we’re pleased to report that we remained on track, with 4 loans repaying during the third quarter. Given the limited transaction activity in the broader real estate market, we believe this reflects positively on the institutional quality of the assets and the sponsors within our portfolio. During the quarter, we also executed two loan sales. The first loan was a Texas hospitality loan, which was sold at par with the intention of reducing our overall hospitality exposure and bolstering our liquidity.

The second loan was collateralized by a San Francisco multifamily portfolio with a rent-regulated component. In the current environment, it’s important to be vigilant. And as part of our asset management process, we evaluate our investments through the lens of optimizing long-term shareholder value balanced against the time and capital required to achieve that value. So in select circumstances, we will consider selling a loan where we no longer have long-term conviction in the investment. This was the case with the San Francisco multifamily investment we decided to sell during the third quarter. It was a difficult decision due to the resulting realized loss. But ultimately, we believe that this portfolio management decision was prudent given the market and regulatory headwinds the investment was facing.

Mike will provide a more comprehensive portfolio review later on in the call, including details of the loan sales. Lastly, as previously reported, CMTG declared a dividend of $0.25 per share for the third quarter, which represents a reduction from prior quarterly dividend levels of $0.37 per share. We considered a number of factors in resetting the dividend, including acknowledging that the current market disruption was and is very likely to persist and the desire to take advantage of potential opportunities that may arise within our portfolio. Given these factors, we looked to establish the dividend at a level where we believe it will be sustainable and comfortably covered by distributable earnings before realized gains and losses and leave us prepared for future opportunities and potential unknowns.

I would now like to turn the call over to Mike.

A real estate CEO pointing to a hospital facility on a financial chart.

Mike McGillis: Thanks, Richard, and good morning, everyone. The third quarter was a dynamic quarter, driven by strong repayment activity and 2 loan sales. Notwithstanding this activity, the portfolio composition remained relatively unchanged, although we had a modest decline in office exposure. To quickly recap, CMTG’s primarily floating-rate portfolio based on carrying value was $7.1 billion at September 30, compared to $7.5 billion at June 30. The quarter-over-quarter decrease was primarily due to loan repayment and loan sale activity during the period, partially offset by follow-on fundings on prior period loan commitments. During the third quarter, we received an aggregate of $475 million in loan proceeds, which comprised $248 million of full loan repayments, about $39 million of partial loan repayments and $188 million from loan sales that Richard mentioned earlier, which I’ll touch upon in more detail later.

In addition, we made follow-on fundings of $174 million. Turning to the composition of our portfolio, multifamily continues to represent our largest sector, representing 41% of the portfolio at September 30. While we are observing borrowers contending with higher interest rates, our long-term outlook for the asset class remains positive. We continue to believe that high-quality, well-located multifamily will perform well on a relative basis, given the strong long-term underlying supply-demand fundamentals favoring the sector as well as the impact of higher interest rates on home ownership affordability. Hospitality, our second largest allocation, represented 19% of the portfolio at September 30, relatively unchanged compared to the prior quarter.

In terms of office, historically, we’ve been highly selective when it comes to office and, as a result, have maintained a low portfolio concentration in this asset class. During the third quarter, we further reduced our office exposure to 13% of the portfolio. This was primarily a result of an office construction loan that repaid during the quarter, as anticipated. The loan was a $141 million loan commitment and was secured by a newly built Class A high-rise office building located in Nashville, Tennessee. This loan is a good example of high-quality office continuing to be attractive and why we believe construction loans serve as a valuable component of our portfolio, particularly when asset-managed with discipline and built-in access to the broader perspective and resources of the Mack Real Estate Group.

We believe that when a new asset is delivered, it will frequently represent one of the highest quality and most in-demand assets in its submarket. As Richard mentioned, we expected a meaningful number of loans to repay, and during the third quarter we received $248 million in full loan repayments, about $39 million in partial loan repayments, with additional loan repayments expected to occur over the near to medium term. We believe it’s important to note how diverse the underlying collateral of these loans were. They represent a cross-section of collateral from various markets and property types and primarily assets that were recently delivered to the market. We believe this suggests that there’s still liquidity for high-quality assets and sponsors, validating the quality of the investments in our portfolio.

Before turning the call over to Jai, I’d like to discuss the loan sales we completed during the quarter. The first loan was collateralized by a high-quality hospitality asset located in Austin, Texas, with a UPB of $123 million, that had seen significant improvement in operating performance during the loan term. We took advantage of an opportunity to sell the investment at par, which we believe speaks to the credit quality of the asset and the investment, particularly in this capital markets environment. The transaction enabled us to enhance our liquidity, further bolstering our balance sheet, while reducing our leverage and exposure to hospitality. The second loan was a $138 million loan originated in 2019, collateralized by a portfolio of multifamily properties with a rent-regulated component located throughout San Francisco.

The borrower continued to support this asset through COVID-19 pandemic but decided to stop making debt service payments in the fourth quarter of 2022 as a result of increasing interest rates and reduced NOI at the property given San Francisco market challenges. Since the time of the payment default, the dynamics of the San Francisco real estate market have continued to deteriorate, which, coupled with the expectation of continued regulatory pressure, led us to the difficult but clear-sighted decision to sell the loan for gross proceeds of $65 million, representing a 53% discount to UPB. While this is a disappointing outcome for the San Francisco loan, it was driven by our belief that there are significantly better uses of this capital, and we were able to use proceeds from the loan sale to reduce leverage, which will be accretive to distributable earnings given that the loan was on non-accrual.

We also believe this demonstrates our commitment to strong and efficient portfolio management, even when it requires moving away from an investment thesis. I would now like to turn the call over to Jai.

Jai Agarwal: Thank you, Mike and Richard. For the third quarter of 2023, we reported distributable earnings, excluding net realized losses, of $0.35 per share, which comfortably covers our revised dividend of $0.25 per share. Distributable loss, including net realized losses, were $0.16 per share. The net realized loss of $73 million, or $0.52 per share, was primarily a result of the sale of the previously 5-rated San Francisco multifamily investment that Mike mentioned. We reported GAAP net loss of $0.50 per share. Please refer to our earnings supplement for a reconciliation of non-GAAP financial measures. I would now like to discuss the overall credit profile of the portfolio and risk rating migration during the quarter. No new loans were added to the risk-rated 4 category.

However, three 4-rated loans were migrated to a 5 rating, zero loans with an aggregate UPB of $335 million, against which we recorded a specific CECL reserve of $71 million. These include a land loan in Virginia and office loans in San Francisco and Atlanta. At September 30, our CECL reserve was $155 million, or 2.2% of UPB. This is comprised of $72 million of specific and $83 million of general CECL reserves. Specific CECL reserves represented 21.3% of the UPB of the underlying loans at quarter-end. The general CECL reserve of 1.2% is comprised of 3.6% of the UPB on 4-rated loans and 0.8% of the UPB on the remaining loans. General CECL reserve increased during the quarter, primarily as a result of deteriorating macroeconomic conditions, offset by seasoning of and a reduction in our loan portfolio.

In addition, we placed another $98 million 4-rated loan, secured by an office building in Irvine, California, on non-accrual status. Non-accrual loans represented 6.1% of our loan portfolio at September 30. Turning to the balance sheet. As Richard mentioned, preserving liquidity continues to be a priority for the organization. At September 30, we reported $433 million in total liquidity, which includes cash and approved and undrawn credit capacity. Unencumbered loans comprised $438 million, which includes $407 million in senior loans as well as $144 million mixed-use New York City REO property. In addition, future funding commitments decreased to $1.3 billion at September 30, compared to $1.9 billion at December 31, 2022. Our net debt-to-equity ratio remained consistent quarter-over-quarter, coming in at 2.3x at September 30.

I would now like to open the call for questions. Operator, please go ahead.

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