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Edited Transcript of LADR earnings conference call or presentation 7-Nov-19 10:00pm GMT

Q3 2019 Ladder Capital Corp Earnings Call

New York Nov 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Ladder Capital Corp earnings conference call or presentation Thursday, November 7, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Richard Harris

Ladder Capital Corp - Founder, CEO & Director

* Marc Alan Fox

Ladder Capital Corp - CFO and Head of Merchant Banking & Capital Markets

* Michelle Wallach

Ladder Capital Corp - Chief Compliance Officer & Senior Regulatory Counsel

* Pamela L. McCormack

Ladder Capital Corp - Co-Founder, President & Director

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Conference Call Participants

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* Jade Joseph Rahmani

Keefe, Bruyette, & Woods, Inc., Research Division - Director

* Joel Dryer

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Steven Cole Delaney

JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research & Senior Research Analyst

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Ladder Capital Corp. Earnings Call for the Third Quarter of 2019. (Operator Instructions) As a reminder, this conference is being recorded.

At this time, I would like to turn the conference over to Ladder's Chief Compliance Officer and Senior Regulatory Counsel, Ms. Michelle Wallach. Please go ahead.

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Michelle Wallach, Ladder Capital Corp - Chief Compliance Officer & Senior Regulatory Counsel [2]

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Thank you, and good afternoon, everyone. I'd like to welcome you to Ladder Capital Corp.'s earnings call for the third quarter of 2019. With me this afternoon are Brian Harris, our company's Chief Executive Officer; Pamela McCormack, our President; and Marc Fox, our Chief Financial Officer. Brian, Pamela and Marc will share their comments about the third quarter and then we will open up the call to questions.

This afternoon, we released our financial results for the quarter ended September 30, 2019. The earnings release is available on the Investor Relations section of the company's website and on our quarterly report on Form 10-Q, which will be filed with the SEC this week.

Before the call begins, I'd like to remind everyone that this call may include forward-looking statements. Actual results may differ materially from those expressed or implied on this call, and we do not undertake any duty to update these statements. I refer you to our most recent 10-K for a description of some of the risks that may affect our results. We'll also refer to certain non-GAAP measures on this call. Reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP are contained in our earnings release.

With that, I'll turn the call over to our President, Pamela McCormack.

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Pamela L. McCormack, Ladder Capital Corp - Co-Founder, President & Director [3]

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Thank you, Michelle, and good afternoon, everyone. During the third quarter, Ladder produced core earnings of $44.1 million or $0.38 per share, reflecting an after-tax core return of 10.9%, comfortably covering our quarterly cash dividend payment of $0.34 per share.

We made $1.1 billion of investments in the quarter, including $732 million of total loan originations, 70% of which were balance sheet loans, in addition to $346.4 million in securities and $8.8 million of real estate.

At the end of September, our undepreciated book value per share was $15.15, and our debt-to-equity ratio was 2.89x. As I discuss our products in more detail, I'll begin with our conduit business, which contributed $6.6 million in Q3 core earnings, reflecting the sale of $140.7 million of loans that settled in the quarter.

I will also note, however, that we priced a second securitization in the third quarter. But the result of that transaction, a core gain of $4.8 million will be reported in the fourth quarter when the deal settles. Conduit loan securitization margins for that business continue to be acceptable, and we are pleased with the performance of that segment. We originated $230.7 million in new loans held for securitization in the third quarter and the fourth quarter is off to a good start. We closed $78.9 million of conduit loans in October and have several hundred million dollars of loans presently under application that we expect to close by year-end, subject to customary closing conditions.

Our balance sheet loan origination business is also doing well. In October, we originated $90.4 million of balance sheet loans, and we have a robust forward pipeline for this business going into year-end as well. We originated $501.3 million of balance sheet loans during the quarter, including $454.9 million of floating-rate loans, with an average loan size of $20.6 million, a weighted average spread over LIBOR of 385 basis points and a weighted average LTV of 70%.

During the quarter, we received payoffs of $429.9 million, resulting in net balance sheet originations of $71.4 million, as originations slightly outpaced repayments.

We continue to see strong liquidity in the market that is enhancing borrower's ability to refinance or sell assets. Our recent focus on new loan originations has been on more lightly transitional assets, including our newly completed but not yet fully leased assets. The property tech mix of Ladder's balance sheet loan portfolio has shifted towards heavier weightings of housing-related and industrial properties during 2019. Those 2 categories comprise 56% of Ladder's balance sheet originations over the first 9 months of 2019, up from 24% during 2018.

Conversely, office and hotel properties comprise only 16% of our originations compared to 49% in 2018. During the third quarter, our real estate equity portfolio continued to provide consistent net rental income from long-dated cash flows that contribute to our recurring earnings. We acquired 7 new net leased properties to our portfolio, with a weighted average remaining lease term of 14.7 years. One sale of property contributed $300,000 to core earnings.

At quarter end, we had $1.2 billion of real estate investments on an undepreciated basis. In the third quarter, we acquired $346.1 million of highly rated securities, with an additional $209.8 million acquired through the end of October. Since the end of last year, we invested a total of $1.4 billion in senior CMBS securities, ending the quarter with $1.9 billion, up from $1 billion at the end of the third quarter of 2018.

As Brian will elaborate on shortly, we continue to look to our securities business to provide reliable returns of 8% to 10% while maintaining the flexibility to sell the securities to reallocate this capital into higher-yielding opportunities as market conditions warrant. We also enjoy the liquidity of our short-dated, highly rated securities portfolio, but this business line is not a new business for us, nor is it just a cash management tool.

Our season trading desk is led by Brian, together with a 6-member investment platform that includes our Head Trader Ed Peterson, who has worked with Brian for almost 3 decades since the creation of the CMBS business in the United States.

The third quarter was characterized by solid earnings, steady loan originations and investment activity. We have not reached to make more aggressive loans or stretched our historical debt-to-equity targets as we remain committed to maintaining a strong balance sheet with conservative credit metrics.

Our multicylinder approach continues to result with sustainable double-digit returns on equity that support a durable well-covered dividend. We designed our platform from inception to give us the flexibility to selectively originate loans with experienced sponsors and strong credit fundamentals, instead of having to push volume. As always, our primary emphasis is on originating loans with a stand-alone basis relative to the value of the underlying real estate that collateralizes our loans.

Our focus on middle repeat -- middle-market borrowers enables us to steadily maintain a granular and diversified book of balance sheet loans that totaled $3.2 billion at the close of the third quarter. We had an average loan size of less than $20 million and a weighted average duration of just 17 months to initial maturity.

With a balanced approach to AUM and an unwavering focus on capital preservation and optimizing ROE, we prefer to make shorter-term loans that allow us to routinely reevaluate the credit risk and return profile of each investment. And if warranted, we require our sponsors to commit additional capital if their business plans are not being met.

In addition, we highly value the ongoing option to quickly reinvest and/or reallocate capital from maturing loans into investments that we view is having the best than current risk-adjusted return potential when loans come due. As in previous quarters, where we provided updates on certain portfolio assets, I'm pleased to reiterate that we do not have any assets that we expect will result in a write-down or a loss to our current investment basis. As an active lender, we are not exempt from periodically having difficult conversations with borrowers. Our long-standing emphasis on capital preservation and maintaining a stand-alone basis relative to the underlying value of our collateral has been helpful in keeping our portfolio returns robust. And we are prepared to enforce our collateral rights and remedies against counterparties whose actions will perform to require us to do so.

Two strong hallmarks of Ladder are our unwavering focus on principal preservation and our ability to respond quickly. We understand that there is a clear distinction between a default and a loss, and we focus on avoiding the latter.

With that, I will now turn the call over to Marc Fox, our Chief Financial Officer.

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Marc Alan Fox, Ladder Capital Corp - CFO and Head of Merchant Banking & Capital Markets [4]

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Thank you, Pamela. In the next few minutes, I will provide some additional detail regarding our financial statements and updates on certain timely topics, including encouraging developments on the FHLB membership front, cost reductions from CLO and mortgage debt refinancing activity and Ladder's overall funding strategy.

In the third quarter, recurring income in the forms of net interest income and net rental income totaled $49.9 million. This income was complemented by $6.6 million of core gains on the sale of loans, $1.2 million of core gains on the sales of securities and $0.3 million of gains from real estate sales. From this income, we paid $40.9 million of dividends and distributions, equivalent to $0.34 per share on 119.7 million shares.

For the third quarter, Ladder's cash dividend payout ratio was 89%, that would be 82% on a rolling 4-quarter basis. Looking more closely at the balance sheet.

In addition to the key asset-related statistics covered by Pamela, it is noteworthy that as of September 30, 97% of our debt investments were senior secured. Senior secured assets plus cash comprised 79% of our total asset base, reflecting Ladder's continued focus on investments at the top of the capital stack.

On the right side of the balance sheet, we continue to strengthen our funding base while minimizing funding costs. During the third quarter, Ladder commenced a long-planned process of refinancing the series of 10-year nonrecourse mortgage loans that we used to finance our own real estate portfolio. Ladder has reached a point in its corporate history, where it is time to start refinancing this debt property-by-property over time. As was the case when we established the initial property financings, Ladder plans to originate new 10-year mortgage loans and securitize them at a profit. In doing so Ladder's goals, including achieving funding cost reductions, lengthening our corporate debt maturity profile and freeing up equity capital for other investment opportunities.

In October, Ladder took additional steps to reduce its funding cost by paying off the remaining $99.3 million of outstanding CLO debt financing held by third parties. The debt was originally issued in 2017 in 2 separate transactions that generated almost $700 million of proceeds at that time. The assets in both CLO collateral pools performed well and the attractively priced financing allowed Ladder to earn levered returns in the high teens over the past 2 years.

This quarter, we were also encouraged by the Treasury Department's public support for mortgage lender access to the Federal Home Loan Bank in its housing reform plan released in September. While we cannot be certain of a decision by the FHFA or its timing, we continue to monitor the situation closely and look forward to a resolution of this matter that benefits both commercial mortgage lenders and the communities in which they invest.

Ladder plans to continue to operate as if our FHLB membership will sunset in 2021, but we're cautiously optimistic about the Treasury Department's position on this subject. We closed the third quarter with an adjusted debt-to-equity ratio of 2.89x within our historically targeted 2 to 3x range. Excluding our portfolio of highly liquid and highly rated securities, our adjusted debt-to-total equity ratio will be reduced to 1.73x.

At quarter end, Ladder had $1.2 billion of unsecured debt outstanding across 3 issuances that mature in 2021, '22 and '25. Unencumbered assets at quarter end stood at over $1.86 billion, reflecting a 1.60:1 unencumbered assets to unsecured debt ratio, substantially over the 1.2x requirement included in our corporate bond indentures.

Since almost $1.3 billion of the unencumbered asset base is comprised of gross mortgage loans, securities backed by gross mortgage loans and real estate, the excess unencumbered assets represent a potential source of future funding. At the end of the third quarter, total available liquidity for new investments was over $390 million. Considering the current environment, I want to briefly touch on how Ladder's business model has insulated our shareholders against falling interest rates.

As of September 30, a 1% decrease in 1-month LIBOR would reduce quarterly core earnings by less than $0.01 per share. The impact of lower rates is limited by the floors on our floating-rate balance sheet loan portfolio and the flexibility and strength of our multicylinder platform that enables us to invest in other asset classes as market conditions change. 100% of our floating-rate balance sheet loans have LIBOR floors. The weighted average of those LIBOR floors continues to rise and stood at 1.70% at quarter end, which translates to a weighted average coupon floor of 6.7%. And on the accounting and reporting front, Ladder is continuing to assess the impact of CECL on our consolidated financial statements.

Important factors influencing the CECL reserve will include the size, composition and risk profile of our loan portfolio as well as current and projected future macro market conditions. In our 10-K, which we expect to file in February, we plan to provide more details surrounding our CECL methodology, our adjustment to the reserve to be recorded in Q1 against equity and our ongoing process.

Finally, as we look out over the next several months, we remain focused on improving our funding profile and achieving positive ratings action. We reported to you in July that Fitch had revised Ladder's rating outlook to positive from stable. And shortly thereafter, Moody's affirmed its positive outlook on our credit ratings. We expect to continue our progress on reducing secured debt, and in that regard, have been closely monitoring the unsecured debt markets. With support of market conditions, we look forward to continuing to make meaningful progress on that front, and in the process, we expect to not only strengthen our balance sheet, but also position Ladder to continue to deliver strong and sustainable core earnings for our shareholders and prudently take advantage of growth opportunities over time.

I'll now turn you over to our Chief Executive Officer, Brian Harris.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [5]

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Thanks, Marc. I'm pleased with our third quarter results, and I'll add a few thoughts about the quarter and explain why we've made some slight adjustments to how we are investing these days, given a very different kind of economic backdrop and how these -- how we see these choices benefiting our shareholders now and in the years to come.

I'll first spend a few minutes on how we are investing, giving the macro concerns we have, while navigating the realities of today's market conditions. While the drop in 1-month LIBOR over the last year has had some negative effect on our net interest income, our funding costs also fell. The bigger cause for the decline in net interest income we saw over the last year has been from spread compression on new loan originations. While that spread compression has been well documented by others, what is less well-known is that the credit spreads on the securities that these loans support have been widening since last November.

In this environment, we prefer to acquire securities at wider spreads and invest in more stable, higher-quality assets, meaning newer or recently renovated properties in more densely populated cities, with a focus on multifamily and industrial property types.

In the third quarter, our balance sheet lending efforts produced a total of $494.6 million in new loans, 68% of which were secured by apartments, mobile home parks and warehouses. The weighted average spread to LIBOR on these loans was 380 basis points, which we believe produces an appropriate risk-adjusted return, particularly given the stability of the assets securing these loans.

As Pamela briefly mentioned, on a year-to-date basis, 56% of our newly originated balance sheet loans were backed by the same property types. So our migration to stability and quality, when lending rates come down, is visible.

In addition, we have acquired about $1 billion in mostly CLO AAA and AA securities over the last year, and our securities produced a levered return of about 8% to 10%, while we wait for clarity around some of the more uncertain macro world events. This is what we call purposeful investing. We are responding cautiously to market conditions and accepting slightly lower returns with a higher degree of safety until we feel more certain about the future. Fortunately, our investment model allows us to easily cover our dividend by a good margin of safety under current market conditions.

We have employed this same strategy throughout our careers, and it has produced extraordinary results. If market spreads improve, we'll pivot quickly into growing our portfolio of balance sheet loans again. If and until then, we'll continue to seek safer investments with acceptable returns until the market volatility passes.

Turning to macro conditions. Let me start by saying we agree with most of the media reports that say the economy is faring pretty well, largely anchored by a strong U.S. consumer. We note however that corporate America is not spending like the consumer while credit card debt is very high and defaults in automobile loans and student debt are rising rapidly, so some caution may be warranted.

While we won't pretend to know when or how the trade war with China will be resolved, we do know that in less than 12 months, our U.S. election will likely put us on 1 of 2 paths that couldn't be more different. As of today, we think that we'll either be faced with massive entitlement programs, getting larger and more numerous while taxes, in general, will be souring or a continuation of a fiscal experiment, whereby the U.S. deficit continues to spiral over the $1 trillion mark while taxes continue to be lowered, both scenarios cause us to be cautionary.

While we think both political paths will evolve into something more reasonable, we feel it might be a fine time to take a slightly more defensive investment profile until we have more clarity on what to expect a year from now. Hopefully, I've offered some insight into our current thinking and investment model. A model that is designed to allow us to respond and evolve in real-time. A model that has produced industry-leading returns since inception. We play the long game at Ladder, and we'll occasionally take up a defensive position, but rest assured, we are already in a position to go on offense when the time is right.

We feel confident that we will see excellent opportunities to achieve outsized returns on investments over the next 18 months. Uncertainty creates volatility and volatility creates opportunities for those with capital and flexibility.

Before I wrap up, the last thing I'd like to mention is that 2019 will be a year where we stuck to our core strategies and lending and securities. You might recall that in 2018, our performance had a fairly large component of core earnings that came from strategic sales of real estate assets that we owned. As I look ahead into 2020, I expect next year to include more supplemental gains as we prepare to sell more assets that we own as they've matured now and stabilized.

And I think we can go now to take some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question comes from Tim Hayes with B. Riley.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [2]

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My first one, Brian, as you move into more defensive assets, how do you see yields trending irrespective of LIBOR movements? And what type of ROE do you think the platform is capable of sustaining as you continue to shift your loan mix?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [3]

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Tim, I would say that yields -- you should know that when we -- when I say we take up a defensive position, we're doing more multifamily, mobile home parks and industrial because they are a little bit more stable and there were some opportunities to step into those markets for various reasons during the last quarter. And it seems to me that the credit spreads that are associated with various property types are very similar right now. And I don't really think hotels should be pricing the same way as apartment buildings.

And so if you're going to be given a price by the market, I think we need to be -- if we're going to pay a fairly tight price, as we all know, there's been some compression in credit spreads, but if we're going to pay a tighter price on all property types, I think if the price is the same, we'd rather get the more stable assets being the apartments and the warehouses. We are still writing hotel loans and office properties, but our rates are much higher than that. And to the extent that the rates on hotels and office buildings are the same as what we see in apartments and industrial properties, we will avoid the hotels and the office products. That's not to indicate to you that we're afraid of hotel or office or the economy right now. It's simply that we express our preferences for our investment based on what we think the long-term stability is on all these assets.

The other thing that we're doing defensively right now, and again, the word defensively, I don't like it necessarily, but what's been happening is credit spreads have been falling on the loans as they are originated. However, the credit spreads on the bonds that are sold in the CLOs that finance these things, they have been going wider. So from a risk-return and liquidity and safety standpoint, to me, it's a hands-down analysis that the securities is a better investment. And so we're able to attain about a 9%, 9.5% return. And we've been acquiring AAA and AA CLO securities at around a 120 over LIBOR type number. When you apply the market leverage to that, you get to around a 9% or a 10%.

As far as where do I think yields will go, I actually think they're widening right now as that tends to happen across the board in the fourth quarter almost every year because there's a lot of tax activity that takes place that has to happen before year-end. And in general, for some reason, a lot of financial companies like to go through year-end with a smaller balance sheet. So they are not apt to try to expand their balance sheet going into year-end. We're very comfortable expanding our balance sheet into year-end.

And so right now, we've got, in my opinion, an extraordinarily large pipeline of loans under application with deposits up. And very pleased with that activity. And I think that margins are very acceptable and yields have been rising on the floating-rate product. And with interest rates rising over the last 10 days or so on the conduit side, you'll naturally see spreads tighten there because as interest rates rise, supply just falls off. If that answered you.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [4]

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That does. Yes, that does. I guess it sounds like you're -- and I know you've always been committed to the bridge business. But it seems like you're still favoring the -- the return, the risk-adjusted returns in CMBS versus the transitional lending space right now, but it sounds like the pipeline is still pretty strong there. So I guess how do you think about capital allocation and just in the different parts of your business growing, I guess, in the near term or over the course of 2020?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [5]

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I think the fourth quarter may be a little bit of a tease because, as I said, the fourth quarter, things get a little unusual because of year-end and tax-driven deadlines. But I would say presently, for instance, I'll give you some quick numbers here. In the fourth quarter, so far, we've actually purchased as of today, I got this number when I walked in here. We purchased about $240 million worth of CLO paper. And we're earning about a 9.5% levered return on that.

However, the pipeline of loans under application in the bridge portfolio has higher rates associated with it right now. So we're actually allocating a lot of capital into that space also. So it's one of those rare times and I would largely attribute this to the fourth quarter, where every product type is working very nicely right now. And profit margins appear to be getting bigger, not smaller as we head into 2020.

I think in the middle of 2019, when there was a flat yield curve, that's a very difficult lending environment for most spread lenders for various reasons and that has started to correct itself. So even that fundamental change is adding to the net interest margin. So I'm very encouraged by that. I don't think interest rates are going to rise dramatically. But at least, maybe they'll be less than flat or worse inverted. So I think the lenders -- I think you have seen a lot of stock crisis at banks and finance companies move up here recently. That's in response really to the finance -- the curve steepening. So we will benefit from that also.

So I would tell you right now, if it appears that we were avoiding bridge loans in the third quarter, that was not the case. We actually had one of our more active quarters. We were simply preferring to be buying securities, but we bought both. I would tell you, as we go into the fourth quarter, those numbers are evening out even more. So I think we may very well be doing more bridge lending right now than we are doing in the securities acquisitions.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [6]

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Got it. That's really helpful. And then just on rate I guess and the amount of floating-rate loans has kind of declined a little bit over the past few quarters. Is that in a conscious effort to go more fixed rate in light of your view of rates? And are you putting floors on all new floating-rate originations?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [7]

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Yes. In 2019, in the middle of the year, I think we stated that our preference would be to invest primarily in the conduit business as well as securities. And we did follow that, and that was as a result of our view that rates would be falling. We had -- if you take a look at the profit margins in the conduit business in the third quarter, they were excellent. And I believe, as of today, we've actually made more money in the fourth quarter already than we made in the third quarter in the conduit business. So those margins are very strong right now, but I don't want to mislead you in that many of those margins are there. The high margin that you're seeing is because rates were falling while there were floors in place.

So we had some somewhat outsized returns. I think that will normalize a little bit as rates rise. But as rates rise, I think we'll get higher credit spreads in our bridge lending business. So that's the way the model works. Whenever something -- I know that there's been a lot of talk about rates falling, and what does that do to your net interest margin, that's fine. We can all figure out net interest margin if you don't have floors in place.

The answer to one of your questions is, do we have floors in place and everything and -- yes, we do. And our floors are actually rising, something not many people realize because loans written 3 years ago actually had lower floors than loans written today. However, as we head into 2020, I would tell you that I think our net interest margin will pick up, our volume will pick up and rates will be higher. However, I don't think we'll enjoy the same margins in the conduit business because those floors that added outsized profits, they are not there anymore.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [8]

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Okay. Yes. That makes sense. And then just a quick housekeeping question. I got the $78.9 million of conduit loans in October, but just missed that number of how much you expect to close before year-end. Can I get that number?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [9]

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Pamela, do you...

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Pamela L. McCormack, Ladder Capital Corp - Co-Founder, President & Director [10]

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We just said several hundred million.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [11]

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We're not giving that number. We're...

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [12]

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Several hundred.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [13]

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We're guessing at it at several hundred million dollars.

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Operator [14]

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Our next question comes from Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [15]

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Brian, when we hear your approach in the near to intermediate term, I think that there are perhaps 2 things that are going on here. One is a -- in terms of driving the strategy, one is a relative value play that you don't see risk or riskier assets being priced appropriately versus less risky assets. And then there is a more absolute value play based on some of your economic and political concerns. I'm curious if that's the right way to think about it. And more importantly, how bad are the signals that you feel that you're seeing?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [16]

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Okay. A couple of parts to that question. One is, I'll go back and hear this recording again because I'd like to say the way you said it as far as relative value in risky assets versus less risky assets. There is a price for, what I'll call, riskier assets, meaning shorter-term assets, meaning more elastic, more levered to the economy. So a hotel, right, is probably the ultimate and short-term leasing. So when the -- we may very well accept a lower ROE on an apartment building than we would accept on a hotel.

And when that differential is miniscule, we'll lean towards the apartments because they are just more stable. They are not going to get -- Amazon hasn't lived in an apartment, you had 4 of them. And so it's just safer. So when you see us possibly accepting slightly lower ROEs, you are correct. It is on a relative-value investment basis. It's not because we're uncomfortable with hotels, we just think that the price of hotels relative to the pricing of apartments is out of whack.

So we don't typically write a lot of apartment loans. If you remember, I think we were 40% hotels at one point a few years ago, we're much lower than that now. And there was a period in time where the agencies, the GSEs really kind of closed down or took a little bit of a holiday in 2019. And because of the rent regulation laws that went into effect, a lot of savings and loans froze also. And that really opened up 120-day period where apartment loans were able to be acquired at much wider pricing.

So we just stepped in there, again, opportunistically. I don't want you to think that we are migrating towards apartments because we're afraid of hotels. You are correct. On a relative-value basis in the third quarter, that was what we expressed in our investment preferences.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [17]

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Got it. In the second part of the question, and I would actually like to rephrase what I said because it sounded probably perhaps a bit more dire than you suggested. But when you look at the economic signals that are of concern, where would you rate the magnitude of that concern?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [18]

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My concern primarily lies with medium- to longer-term likelihoods as opposed to what's happening right now. I mean there's a -- the band is playing, the champagne is out, unemployment is low, wages are rising and there's seemingly no problem at all. And that's kind of true. I think that the economy is bouncing along pretty nicely here. I don't think it's booming, but I think it's doing okay. Where my concern comes in is after 10 years of extraordinarily low interest rates, we've got a 2% GDP, which is okay, nothing wrong with it, but you might have thought higher. There's a bit of a worldwide problem going on, a slowdown. Corporate America is signaling a hesitancy to spend, which may be motivated by the economy and what they're seeing or it may be motivated by their concern about which way the next election is going to go.

Frankly, I'm a little concerned about either way the election goes. As far as in the long term, with a Republican victory, are we going to continue to spiral the deficit. And I mean the deficit used to be something people worried about. It's not anymore. Apparently, there's been a new theory that as long as there's a small part of your GDP, it doesn't really matter. I'm not sure I believe that one, but that's the narrative that's playing out in the country today. And the democratic alternative looks like a massive expansion of many, many government programs and entitlements and the only way to pay for it, raising corporate taxes and individual taxes, and I have no doubt that will turn into property taxes and other.

So we've kind of had a quick view of what can happen when taxes start becoming irrelevant as far as how high they go. And you're seeing it in the high-end Manhattan condominium market, where they obviously limited state and local taxes. They got rid of a lot of foreign buyers. And then there was a mansion tax, and now they're talking about putting on a second home tax for out of towners. And that market has been hammered in New York City. So obviously, we're a national lender. But -- so is it dire? No, it's not. Could it be? I think it's very bad in high-end residential condominiums, I think that's dire. But it's -- to me, it's just a lowering of price because you've really just made it very hard to own over the long term.

And -- but on -- when I look at the properties and how they are performing, I think hotels are doing fine. I don't think they'll be doing better next year. I think they peaked. I think they are doing as well as they could be. I don't see them in trouble. So they could go along here for a while, just like this, industrial properties are doing very well. Obviously, as retail gets hurt, industrial does better. And the apartment market, because a lot of housing is out of price range, and a lot of people have jobs, apartments are doing pretty well. So it's not dire at all. But there could be some clouds building that could be a quick catalyst could step into them in the next 15 months. And I don't think it will be positive.

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Operator [19]

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Our next question comes from Steve Delaney with JMP Securities.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research & Senior Research Analyst [20]

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To -- for starters, we were pleasantly surprised by the $500 million of new balance sheet loans in the quarter. And thank you for explaining the focus there with housing and industrial. Is there -- can you comment on the number of loans and mention whether there's anything chunky in there? Trying to just figure out if that looks like as you go into next year, that might be a sustainable -- near-sustainable quarterly level for that type of financing.

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Marc Alan Fox, Ladder Capital Corp - CFO and Head of Merchant Banking & Capital Markets [21]

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So Steve, we originated 24 balance sheet first mortgage loans during the quarter.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [22]

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What was the average?

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Marc Alan Fox, Ladder Capital Corp - CFO and Head of Merchant Banking & Capital Markets [23]

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And the average size of those balance sheet loans that we originated during the quarter, we originated $500 million worth.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [24]

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$20 million.

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Marc Alan Fox, Ladder Capital Corp - CFO and Head of Merchant Banking & Capital Markets [25]

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So a little bit more than $20 million.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [26]

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Nothing. I did see, I think, the $90 million loan in one of them. But I don't think we have things over $100 million that I can recall. We would love to write slightly larger loans because, frankly, at this point, I talked to panel the other day about how busy we are going into year-end. And she said we might need to hire some more people. We will just have too many things closing. And my first answer to her was, we'll raise prices because that means we have got too much volume coming in here. So we do stick to that middle-market model. And I think our average loan size has been between $18 million to $25 million for a long time.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research & Senior Research Analyst [27]

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Great. And we see 2 closed conduit deals so far in the fourth quarter. Obviously, a lot of rate volatility and I don't know how that's going to affect the second half of 4Q. But can you comment on the probability that you will be able to participate in a third transaction before the end of the year?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [28]

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Sure. We have participated in 2, and I believe we've made $7.5 million so far this quarter, in the fourth quarter. And the -- there's a very good probability -- high probability we'll participate in a third one, which I think will probably be bigger than the other 2. However, we are somewhat dependent on other people, right, and partners on that deal, but Wall Street partners are typically very motivated to get things done before the end of December. So I would say the probability is higher, I think, going into this quarter end than most. And as I said, I think it will be bigger. I also think we'll track over year-end with a much bigger balance of conduit loans to be securitized going into 2020. We are trying to acquire a lot of assets right now.

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Operator [29]

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Our next question comes from Jade Rahmani with KBW.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [30]

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You made some cautious comments around office. I wanted to ask you about coworking and WeWork. My understanding is WeWork absorbed a significant amount of vacancy in New York, for example, which could have artificially propped up the office market for a couple of reasons, one, by resetting rents to higher levels, taking that vacant space off-line, but also in the transitional space, sponsors could underwrite that last mile of vacancy, assuming that WeWork would take it. I saw a stat today that even in the third quarter, WeWork was 69% of the market, although they've pulled back. So just curious about your thoughts around that trend in the office space.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [31]

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Sure. I actually asked a few of the larger landlords around the country and we do have some loans out to them. First of all, our exposure to WeWork is de minimis. We've got an exposure them in a building in the Midwest, which is not very high in that building, and that's it. I think you've asked us a few times these questions around coworking space, and I think I may have indicated that unless it was the parent on the lease, I would not have even considered using WeWork as a tenant that we would bank. And in fact, at least that we do have them in our building, the parent is on that lease.

So with the recent rescue, I guess, of -- by SoftBank, that is the company that is backing that lease. And also it seems to me that obviously they are a very large acquirer of space in a very short period of time. And just market dynamics tell me that when you acquire a lot of things in a very short period of time, you probably paid a little too much for it because you were out-competing a lot of other people. So I think against the backdrop of WeWork, which I'll call, I don't know, 10% maybe of the space, it's going to come -- I think a lot of it will come back on the market. I don't know, it may not.

But I think the market is already softening a little bit, just generally. So I think if it had a -- I think it had a muting effect on the way up because I think that they were paying high prices in a market that was softening. And now I think there's going to be more space coming back on the market in a market that's falling. So that may have a bit of an outsized feel to it. And -- but -- so if I had to guess, what do I think going to happen in New York City rents in the next 24 months as a result of coworking space being less dependable, maybe a 10% drop. I don't think it's fatal by any means, especially in a lot of markets that they are in.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [32]

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10% drop in rents?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [33]

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Yes. I think so.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [34]

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Wow. Okay. So just a follow-up. You would also see cap rates widen in that scenario, and then you have a lower NOI. So you're saying that you expect office values to decline more than that over the next 12 months.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [35]

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About that. Yes. I would go along with that probably.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [36]

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Okay. That's interesting. So how does that play into Ladder's office exposure specifically? Any issues of concern right now?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [37]

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No. I think the concerns that are out there as far as what we're seeing, I mean the economy is still doing fine, corporate America earnings are okay. And as I've said many times, I think if and when a recession does come, I don't think it will be nearly as difficult as some people fear, mainly because of the expansion and the recovery has not been nearly as euphoric as many people have thought.

So you did hear me say that we're preferring -- at a similar price, we are preferring apartments, mobile home parks and industrial properties as opposed to office and hotel. I don't put office in the same category as hotel, but I put it closer to hotels than I put it to apartments. So how is it affecting us? And we are pricing higher and we're not acquiring as many office loans as a result of that and that's by design. If we want to add office product, I think we can do that. If we simply lower our spreads to where we're doing apartment loans, we'll have plenty of office buildings here.

So we curate our portfolio, and we try to make sure that we're responding to what we perceive. Again, I see a lot of the stock traders that say, well, if it looks like a Democrat is going to win the election, you should sell your stocks. When you're making loans that you're going to get paid back in 3 to 4 years, you're not going to have that opportunity.

So the time to start boarding up and protecting things is well in advance of that. So I don't know what's going to happen. And I don't know which one I fear more, but I do fear that there is a lack of discipline in the financial system right now and a bit of complacency on the investment side. I understand why stocks are trading at all-time highs and I understand why employment is at an all-time low, I'm a little bit concerned as to what the cost of those 2 statements has been and it's translating into the deficit. And I sound like an old man when I talk about it, but I am a little concerned about a deficit that went from $400 billion to $1 trillion very shortly -- very quickly.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [38]

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Pamela went through some of the way Ladder approaches asset management in a proactive manner. I fully appreciate that. I think it's much better than lending, pretending and extending. But on that note, can you just think about or talk about the magnitude of potential upcoming maturities, noting that maturity default is one big driver of at least credit defaults? And are there any credit issues that you're watching closely that you'd expect to arise in the next quarter or 2?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [39]

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Jade, I'll let Pamela talk here in a second. But I think what you'll hear from Pamela is a big distinction between default and loss. And you're correct, you can certainly extend a loan when LIBOR is at 175 and probably get somebody to put up a few dollars for interest and kick the can down the road. Ladder believes if there's a problem, you should get at it when the capital markets are very liquid, when aggressive lenders exist and when refinance possibilities are plentiful and before that same sponsor might have 2 or 3 problems on his hands. So we are probably an early warning system that we are very aggressive in how we approach maturity deadlines.

As I've said in the past, one of the annoying borrower habits is when a borrower has a maturity coming up and the building is not for sale, and he has not looked for an extension and his belief is that he's going to get an extension with us and he hasn't sought to refi rather. That's a poor discipline that we don't really like to encourage. And if a borrower does need an extension, and he's willing to write a substantial check to recommit himself to the equity, then we're happy to extend it, oftentimes charging fees and raising rates because we prefer things to happen on time unless there's a reason.

Do we have some things coming up near term? We have a $60 million loan that is recently defaulted as far as the maturity default went. I'll just point out, it's actually been discussed a little bit in the Austin newspapers. It's the old 3M headquarters in Austin, Texas. And the borrower purchased it just 18 months ago, north of $80 million, has $22 million in equity in the building. We swept cash flow for 18 months and the building is now empty. It's almost 1 million square feet and there's 160 acres of land, with another 1 million square feet of as-of-right buildable space in probably one of the healthiest markets in the United States.

If we were to foreclose on this property and take ownership of it, we would own it at about $70 a square foot on the existing building, giving no value at all to the land or the other 1 million square feet. The borrower extended this loan with a 7-figure paydown right before we gave them 30 more days. And he had -- we believe he was looking to refinance it with several hundred million dollars in a loan that would have been a full redevelopment. However, the FBI went into his offices, seized computers and records. And there's been no charges filed but the refinance fell down. So when the borrower suggested potentially extending the loan, we reiterated that it would require a paydown of principal, not just the reloading of interest and the loan went into default. And it may pay off the loan at a default rate, it's presently accruing at 13.8%, and we're pretty comfortable with it.

So there is a default not anything that's concerning us and not anything that we're expecting to take any write-downs on. And if it pays off, great, if it doesn't, that's okay, too. And we are in Texas, Texas seems to be quick.

And so again, I think I've mentioned to you where we're seeing these problems bubble up is where there's no cash flow and the borrowing needs an extension. And there's another example of it right there. I mean he -- when you want to extend a 16 -- a $60 million loan, you have to put up a year of interest at a high rate. That's a lot of money. And the mistake was made in that the first 18 months, not finding new tenants and waiting perhaps too long to refinance it.

So as I said, no one has been charged with anything. And so we're hopeful. We hope the borrower can keep the property, but he'll have a very high interest rate that goes with it at this point. And you should also note too that this is an unusual phenomenon in this part of this recovery.

In 39 years, I never really saw law enforcement in real estate owners offices, but we had another one last quarter that the FBI was in the offices of a Upstate New York property owner, and we had a $39 million loan out to them. And it did pay off. I mean he had a maturity coming up, and he did pay us off. But I've rarely seen law enforcement looking in real estate owners' buildings as much as this. And when it happens, immediately, all refinance activity stops. So if there are large substantial holders of real estate, they ultimately wind up defaulting quite a bit. But again, that doesn't cause us concern as a lender because of the basis that we lend at going in. So in this example, in Austin, Texas, it's $22 million in equity 18 months ago.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [40]

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Okay. And any other upcoming maturities that are on a -- mid-term maturities on a watch list?

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Pamela L. McCormack, Ladder Capital Corp - Co-Founder, President & Director [41]

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So we maintain a robust watch list and that watch list include any maturities. But what I would tell you, Jade, is there are a small handful of loans where we're in some of the same -- I think Brian covered it well, we're in conversations with borrowers about putting in more capital, and we are taking a hard line across the board. In order to gain an extension, you have to recommit additional capital, submit a business plan that we think is superior to one that we could execute on our loans, because as Brian mentioned, we really are a basis lender and look at the underlying value of the real estate and feel very confident.

I think one thing that really distinguishes Ladder, the fact that we do own and operate 7 million or 8 million square feet of real estate, we're very comfortable taking back property, and we know what to do with it. And the Omaha hotel was a really good example of that. That just opened and was reopened as a Hilton, it's operating and you can make reservations onto the website. That was a good example of why and how we would step in. So I guess the best way to say it is we are in a few conversations, but we are not looking at any assets that we have any concerns about or that we expect to take a write-down or loss for.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [42]

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Okay. Great. I definitely appreciate the proactive approach. I think that's the right way to go about it.

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Operator [43]

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(Operator Instructions) Our next question comes from Joel Dryer with LTC Partners.

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Joel Dryer, [44]

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I have two questions. Number one is over the last 7 quarters, the LTV on your balance sheet loans has crept up 400 basis points to 70% LTV. I just want to know what might be driving that?

And the second question is, you mentioned retail, Brian, how is the DG portfolio just the activity and just kind of some viewpoints on what's happening over there as well?

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [45]

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Sure. The 66 -- is it a 66% LTV to a 70% over 7 quarters?

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Joel Dryer, [46]

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That's correct.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [47]

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Yes. My guess is that's probably -- that's almost the same number. But obviously, it's higher. My guess is that's very reflective of our movement over to apartments as well as industrial properties because we use much lower leverage on hotels. And I think the second -- is that helpful?

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Joel Dryer, [48]

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Yes. That answers that question. I appreciate that, it's the shift in sectors. And then the other question was color on the GD -- DG portfolio on growth and things of that nature.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [49]

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Dollar General is one of my favorite companies as you know. And they have an incredible business model, and it's one of the few retailers in the United States that not only is thriving, but it's expanding at a rapid pace. There are many technical reasons why DG is a wonderful credit for us to put on our balance sheet for the long term, fully signed brand-new properties with 15-year leases, many of the properties that we acquire are move -- is moving a Dollar General that's been in place in an inline shopping center for 25 years, and now it's moving across the street to a stand-alone.

So they understand their market intimately at that point when they are moving across the street with a new store. And there are such small investments that they tend to trade at wide cap rates, which generate enormous returns. And the reason why is because the expenses that are associated with acquiring such a small asset, on a -- the Dollar Generals cost $1.4 million, generally. And if you're going to buy one of them, you're going to get a very big legal bill and a whole lot of other builds from various reporting companies. However, if you're going to buy 100 of them, you're going to be getting some economies of scale. We actually acquire our Dollar Generals, where if we do close on the transaction, our expenses are paid for by the seller. So it's an extremely efficient business for us as long as you're comfortable with the credit, and we are.

Dollar General continues to expand and their same-store sales do great. Their customer is not necessarily Amazon Prime and is not necessarily getting things delivered to the house on a regular basis. So in many ways, Dollar General comes in behind Walmart, when Walmart closes sometimes. And while I wouldn't call that great real estate, I would tell you they become this general store of the small town that they're in. We probably buy 3 out of every 10 that we look at. And I want you to think that we're just waving in the corporate credit. Do we require a certain amount of people nearby. Many of their stores are in rural areas.

We also try to acquire Dollar Generals, where we don't expect there to be much slippage in the inventory. And yes, it's just been -- it's been a good program for us. We own presently 91 of them. And the other thing that I think Marc mentioned is we're beginning to refinance some of our triple-net properties, I know that we refinanced a few Walgreens recently, where we had been making 13%, 14% cash-on-cash returns. We're taking small position cash out, rates going down and the cash-on-cash return is now exceeding 20% going forward for the next 10 years.

So we like the business. We're very particular about it. We don't go in and buy them widespread with reckless abandon on any corporate credit, we actually look at the real estate. The typical Dollar General real estate box is about $140 a foot. And when you compare that to what a Walgreens or a CVS costs in some of these smaller towns, it really is a much safer play. That's assuming there is a default. I don't think it's going be -- it would be painful. I wouldn't say it wouldn't lose money. But I don't think it would lose nearly as much money as a Walgreens that might close.

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Operator [50]

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That concludes our Q&A session. I'll return the call to Brian Harris, the company's Chief Executive Officer.

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Brian Richard Harris, Ladder Capital Corp - Founder, CEO & Director [51]

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Okay. Thanks, everybody, who listened to the call tonight. Very pleased with the third quarter. It's always a interesting time to talk to you at the end of the third quarter because after the fourth quarter, I don't get a chance to talk to you again for until around April or May. So I would just say that probably the flat yield curve, if it disappears, that will be very helpful. Rising rates is going to be a good thing, if that does occur. However, Ladder is built to perform in uprates or down-rate scenarios for everything that goes wrong when rates go down, something else goes right, we build it that way on purpose.

And I think that we've had a very good year. And I think that competition has abated a little bit. I think it was very aggressive in the second quarter, and we are looking forward while -- we do expect some volatility, and I'm not counting on all of that. But as we move into the first quarter, I think that we're going to go into 2020 with a very full back. And I look forward to also selling some real estate next year because some of our assets have matured at this point. We didn't have any real punch that was -- the thing that punches our ROEs up into the low teens. But I do believe next year, we will.

So with that, I will say goodbye to you for the year, and thanks for your support.

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Operator [52]

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This concludes today's teleconference. You may disconnect your lines at this time, and have great day.