Blackstone Mortgage Trust : Transcript - Q3 2022

Blackstone Mortgage Trust Third Quarter 2022 Investor Call

October 26, 2022 at 9:00AM ET

Operator: Good day, everyone, and welcome to the Blackstone Mortgage Trust third quarter 2022 investor call hosted by Weston Tucker, Head of Investor Relations. My name is Ben, and I'm your event manager. During the presentation, your lines will remain on listen-only. If you require assistance at any time, please press star zero on your device and the coordinator will be happy to assist you. I'd like to advise all parties that this conference is being recorded for replay purposes. And now, I would like to hand it over to your host. Weston, the word is yours.

Weston Tucker: Great. Thanks, Ben, and good morning and welcome to Blackstone Mortgage Trust's third quarter conference call. I'm joined today by Mike Nash, Executive Chairman; Katie Keenan, Chief Executive Officer; Austin Pena, Executive Vice President, Investments; Tony Marone, Chief Financial Officer; and Tim Hayes, Shareholder Relations.

This morning, we filed our 10-Q and issued a press release with a presentation of our results, which are available on our website and have been filed with the SEC. I'd like to remind everyone that today's call may include forward-looking statements which are uncertain and outside of the company's control. Actual results may differ materially. For a discussion of some of the risks that could affect results, please see the Risk Factors section of our most recent 10-K.

We do not undertake any duty to update forward-looking statements. We will also refer to certain non-GAAP measures on this call, and for reconciliations, you should refer to the press release and our 10-Q. This audio cast is copyrighted material of Blackstone Mortgage Trust and may not be duplicated without our consent.

For the third quarter, we reported GAAP net income per share of $0.60, while distributable earnings were $0.71 per share. A few weeks ago, we paid a dividend of $0.62 per share with respect to the third quarter. If you have any questions following today's call, please let Tim or me know. And with that, I'll now turn things over to Katie.

Katie Keenan: Thanks, Weston. The capital markets today reflect significantly heightened uncertainty around global economic conditions. But on the ground, BXMT's fundamental performance this quarter once again underscored the stability, resilience and earnings power of our business.

We have always run this company according to our core principles: low leverage, strong borrowers and high-quality real estate, backed by a conservatively structured match- funded balance sheet. The importance of these principles is most apparent in environments like the one we face today.

Though most institutional real estate owners expected higher rates to come, the speed and slope of the rate hikes have been more aggressive than anticipated. But given the key

tenets with which we originated our loans, they are well positioned to withstand the impact of higher rates. At the same time, the growing earnings power across our entire portfolio provides a powerful ballast amid an evolving credit backdrop.

This quarter, we generated $0.71 of distributable earnings, up an impressive 13 percent year-over-year. Our retained earnings grew book value, even as we increased our reserves. And we drove these robust results while maintaining $1.7 billion of liquidity, more than double our March 2020 level.

We entered the fourth quarter strategically positioned to play offense in a highly opportunistic investment environment, while continuing to generate attractive durable income for our shareholders.

The current market reflects a lack of visibility on the pace of interest rate hikes and where they will settle long term. As a result, asset prices are volatile, impacting liquidity and restraining investment activity. And while the public markets are more reactive to this day-to-day uncertainty, what matters for real estate over time is fundamental performance. High-quality real estate that can capture rent growth is resilient in inflationary environments, as replacement cost rises and cash flows outpace higher operating expenses and rates.

There's nearly $400 billion of institutional real estate capital sitting on the sidelines. And while it will take time, as the rate picture crystallizes, liquidity will flow back to hard assets that generate attractive yields.

If long-term rates settle out in the range of their current levels, some asset values will need to reset. But unlike the GFC [Great Financial Crisis], there is neither overleveraged nor overbuilding weighing on the system, and most reasonably levered capital structures will be able to absorb a reset in rates with impact to the equity returns, but still a positive outcome for the debt.

This quarter, we saw once again that the BXMT portfolio is weathering the capital market storm, a result of the low basis at which we start our senior loans, our credit selection process, our rigorous loan structuring and our sponsorship. We continue to see that the value-add business plans we lend against can capture increasing rents in an inflationary environment, which should support asset values and credit performance over time.

Moreover, 96 percent of the loans in our portfolio have rate caps, which insulate borrowers from further rate increases or other structural enhancements, including carry guarantees or substantial interest reserves. The result is our continued 100 percent interest collection, despite a 300 basis point increase in SOFR since the beginning of the year.

While our positive experience to date is an important indicator, as a lender, we naturally consider many scenarios, including the potential for conditions to further deteriorate. In this respect, we look to the position and incentives of our borrowers. With an average

loan LTV of 64 percent at origination, our sponsors have 36 points of equity to protect as a starting point. Even in a materially higher rate scenario, the incremental carry costs borne by borrowers represent a small fraction of the overall deal capitalization, just one to two points of additional equity a year, well within our sponsor's capabilities and justified for assets with value to protect over the long term.

This commitment is reflected in the behavior we saw in the pandemic when our sponsors injected over $0.5 billion of additional cash to carry their assets, and we see analogous behavior today with our sponsors having invested $275 million of incremental cash equity so far this year.

Turning to the office sector, while the office segment faces secular headwinds, it is further impacted today by regulatory pressure at banks and a broad-brush approach typical in periods of economic pullback. There are many older vintage commodity office buildings that will suffer. But there is also a significant segment of the institutional market where high-quality office is seeing continued tenant demand and rent growth.

For example, this quarter saw New York City's strongest leasing activity since COVID, up 28 percent year-over-year and roughly 10 percent above third quarter '19 and the five- year pre-COVID average. And that leasing activity is concentrated in Class A buildings, which despite being only one-third of New York City's stock, captured 74 percent of leasing in the third quarter.

In most of our office portfolio, we see stable occupancy, ongoing sponsor commitment and particularly notable in today's environment, continued repayments, with $349 million in office loans repaying over the last three months, including a vacant New York City office slated for renovation, which just occurred post quarter end. Our office portfolio is 92 percent Class A, 100 percent performing, and generally characterized by high-quality,well-amenitized buildings that are outperforming in today's leasing environment. A third of our collateral is brand-new construction, including the new build headquarters of Pfizer and Warner Brothers. And across our portfolio, we have assets recently leased to major law firms and creative users, private equity finance and tech.

We lend to highly experienced, well-capitalized sponsors like Tishman Speyer, Oaktree, Related, and JPMorgan. And this year, our borrowers have contributed over $150 million of new incremental equity to our office deals alone, indicative of the value they have to protect and their continued commitment to the assets.

While we believe the vast majority of our office portfolio is well-positioned for the post- COVID environment, we downgraded four office loans to 4's this quarter. These loans, which represent just three percent of our portfolio, continue to perform, pay interest and in most cases, show positive leasing and material recent sponsor cash commitments.

But having evaluated each asset in our portfolio in detail, we felt downgrades were warranted in these specific cases, denoting a heightened risk of underperformance. We remain focused on actively managing these loans as well as our broader office portfolio in this more illiquid environment.

Importantly, the overall performance of our collateral assets across the portfolio continues to show strength. We also had ten upgrades this quarter as assets ramped up and stabilized. With higher rates and less overall transaction activity in the market, assets that have completed their business plans are staying in our portfolio longer as patient sponsors opt to hold rather than sell into the current conditions.

We are also keeping a close eye on Europe and the UK in light of rising inflation, elevated energy costs, and increasing economic uncertainty.

Our underwriting process is consistent across borders. Just as in the US, we have been highly selective about sponsorship, real estate quality and credit in our European lending practices. Our collateral is concentrated in high conviction sectors, and in many cases, the LTVs on these loans are lower relative to similar US transactions. And just as in the US, we have seen strong consistent credit performance in our Europe book.

Notwithstanding the macro challenges, the dislocation in Europe today is presenting appealing investment opportunities. This quarter, our primary origination activities were in cross-diversified pools of European industrial where vacancy is 1.5 percent and the rent growth is nearly 20 percent.

Our overall originations this quarter averaged 58 percent LTV and an all-in yield of 5.41 over base rates, a high single-digitall-in unlevered return. With the securitization market frozen and banks seeking to reduce their balance sheet exposure, we expect a target-rich environment in the US as well.

While regular-way transaction flow is more limited given a disconnect between buyers and sellers on valuations, we are starting to see both recapitalizations at reset bases and secondary loan purchase opportunities where we can partner with motivated counterparties to provide liquidity at compelling risk-adjusted returns. Going forward, we expect an increasingly attractive investment environment, and we are fortunate to have ample dry powder to address it.

Turning to the balance sheet, our liquidity risk management approach and diversification put us on solid footing to address this more volatile but opportunistic environment. Our robust liquidity position today is by design. The result of our actions early in 2022, when seeing hints of dislocation in other corners of the market, we opted to fortify our capital base and slow regular way originations to best position ourselves for what we saw ahead. And from the outset of our business, we have run a matched balance sheet, insulating our performance from term, currency, and interest rate risk.

We have diversified sources of corporate and asset level capital, a material advantage in an environment where much of the market is sidelined.

As a premier investor and one of the largest owners of real estate in the world, Blackstone is a trusted partner of the banks. Our track record as a borrower affords us

best-in-class terms throughout our business and helps us to secure lending capital as banks consolidate business to their top clients, including a new £1 billion credit facility just this quarter.

Looking ahead, much depends on the Fed's management of the delicate balance between inflation and recession. But our navigation of this turbulent market is deeply informed by the unparalleled investment experience and knowledge base of the Blackstone platform, which has a long history of performing for investors through cycles. BXMT's track record, including the last period of severe dislocation in 2020 through today, evidences the results of our positioning: stable asset and liability performance and highly attractive earnings growth that is rare in today's market.

With a floating rate portfolio, our income is still growing. Third quarter average SOFR was 2.45, and it is already 120 basis points higher at 3.65 today. For our asset-sensitive portfolio, each incremental 100 basis point increase in rates results in $0.06 of increased earnings quarterly, all else equal. This powerful earnings dynamic creates meaningful resilience for our business in two ways. The first, building book value, which helps insulate against increasing reserves or potential credit issues and second, ensuring our

dividend remains well covered in a wide range of scenarios. Together, these elements strongly support our ability to deliver a reliable overall return to our shareholders, even if credit conditions weaken.

Today, BXMT is trading at roughly 88 percent of book value, 8.5 times P/E, and a 10.3 percent dividend yield, metrics that we do not believe reflect the resilience of our business model and earnings stream, our long-term credit track record, or the clear differentiation of the Blackstone real estate platform.

Our current dividend yield is 620 basis points above the 10-year, well wide of our pre- COVID average, despite our company now having growing earnings, significantly stronger dividend coverage, a high integrity balance sheet with more than double the liquidity, and a performing portfolio that has been reoriented to stand up to today's inflationary pressures.

Less than 10 percent of US stocks today offer yields above the 10-year treasury rate and we are paying a dividend yield that is more than two and a half times that level. We've paid that dividend for 29 consecutive quarters and we're covering at over 115 percent today. In a volatile market, current income is key and BXMT is delivering.

With that, I'll turn it over to Tony.

Anthony Marone: Thank you, Katie, and good morning, everyone. This quarter's results showcase positive impact of rising rates on BXMT's floating rate loan portfolio with another consecutive quarter of meaningful earnings growth, supported by the stability in our book value, portfolio metrics, and capitalization.