Ladder Capital Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2024

There are 8 speakers on the call.

Operator

Good morning, and welcome to Ladder Capital Corp. Earnings Call for the Q2 of 2024. As a reminder, today's call is being recorded. This morning, Ladder released its financial results for the quarter ended June 30, 2024. Before the call begins, I'd like to call your attention to the customary Safe Harbor disclosure in our earnings release regarding forward looking statements.

Operator

Today's call may include forward looking statements and projections, and we refer you to our most recent Form 10 ks for important factors that could cause actual results to differ materially from these statements and projections. We do not undertake any obligation to update our forward looking statements or projections unless required by law. In addition, Ladder will discuss certain non GAAP financial measures on this call, which management believes are relevant to assessing the company's financial performance. The company's presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. These measures are reconciled to GAAP figures in our earnings supplement presentation, which is available in the Investor Relations section of our website.

Operator

We also refer you to our Form 10 ks and earnings supplement presentation for definitions of certain metrics, which we may cite on today's call. At this time, I'd like to turn the call over to Ladder's President, Pamela McCormack.

Speaker 1

Good morning. We are pleased to present an overview of Ladder's performance for the Q2 of 2024 and an update on our progress towards becoming an investment grade company. During the quarter, Ladder generated distributable earnings of $40,400,000 or $0.31 per share. This performance yielded a return on equity of 10.2%, supported by modest adjusted leverage of 1.4 times. In addition, we successfully priced a $500,000,000 7 year unsecured corporate bond offering, resulting in positive rating actions from all 3 rating agencies.

Speaker 1

We're pleased to note that both Moody's and Fitch placed Ladder on positive outlook and S and P upgraded both our corporate credit rating and our bonds. Moody's and Fitch are 1 notch away from a signing ladder and investment grade rating. We believe this milestone will enhance our distinction among peers in the commercial mortgage REIT space and position us as an attractive option for traditional equity REIT investors. Pro form a for the $500,000,000 offering, 53% of our debt is comprised of unsecured corporate bonds. As of July 25, Ladder has $1,900,000,000 in liquidity with $1,600,000,000 or approximately 30 percent of our balance sheet comprised of cash and cash equivalents.

Speaker 1

With this enhanced liquidity, we can now squarely focus on offense. As we have stated in the past, our core objective is striving for the highest possible return on equity, while prioritizing principal preservation and employing modest leverage. This disciplined and differentiated strategy supported by our diversified business lines and conservative capital structure has enabled Ladder to generate stable and attractive returns. Specifically, over the past 12 months and against the challenging backdrop, we reduced assets to $5,000,000,000 from $5,600,000,000 from loan payoffs and asset sales, almost doubled our liquidity to $1,900,000,000 as of July 25, reduced debt resulting in a modest adjusted and gross leverage of 1.4 times and 2.2 times respectively, increased our component of unsecured debt to 53% from 40% pro form a for the bond offering that closed in July grew unencumbered assets to $3,100,000,000 or 62 percent of assets, with 82% comprised of cash, securities and first mortgage loans, preserved a stable book value and finally, we achieved all of this while providing a healthy return on equity to shareholders of over 10% while building up a large liquidity position. Turning now to our balance sheet loan portfolio, which totaled $2,500,000,000 as of quarter end.

Speaker 1

With a weighted average yield of 9.48 percent and limited future funding commitments totaling $94,000,000 our earnings for the 2nd quarter included a 1 point $6,000,000 or 5.4 percent gain from the sale of approximately $29,000,000 of fixed rate loans into a recent CMBS securitization. In the Q2, we originated a $16,000,000 first mortgage balance sheet loan secured by an industrial portfolio in Florida. Additionally, we made a $13,000,000 passive equity investment in a joint venture with a seasoned operating partner to strategically acquire a Class A office building in the Plaza District of New York City. The asset was acquired from an institutional investor who owned the asset for over 20 years with favorable financing arranged through the existing lender. We're well capitalized and anticipate further expansion of our loan portfolio for which our originators are actively pursuing new investments.

Speaker 1

Regarding our current loan portfolio, we remain proactive in asset management. In the second quarter, we received $255,000,000 in loan paydowns, including the full repayment of 13 loans totaling $242,000,000 In addition, 4 more loans totaling $56,000,000 were repaid after the quarter ended. Year to date, we received $668,000,000 in total loan pay downs, including the full repayment of 32 loans totaling $618,000,000 We've also been active in opportunistically divesting owned real estate. In total, we sold 3 assets securing loans that defaulted during the first half of the year at a gain above our basis. 2 multifamily assets located in Longview, Texas and Los Angeles, California with a total carrying value of $20,000,000 were sold in the 2nd quarter resulting in a net gain of $1,000,000 Additionally, a third multifamily asset in Texas valued at $11,500,000 was sold at a gain above our basis after the quarter ended.

Speaker 1

We're continuing to demonstrate that defaults do not necessarily lead to losses. We take pride in our capability to own and manage properties, including our readiness to inject capital when necessary or to strategically expedite asset sales as appropriate to maximize their value. There were no specific impairments identified during the quarter and we modestly increased our general CECL reserve to $54,000,000 which we believe is sufficient to cover any potential loan losses we may incur. Turning now to our securities and real estate portfolios. We purchased $81,000,000 of AAA rated securities with a weighted average yield of 7.1% during the quarter.

Speaker 1

We ended the 2nd quarter with $481,000,000 securities portfolio, primarily consisting of AAA rated securities earning an unlevered yield of 6.92 percent, and we have been actively acquiring new securities to add to the portfolio in the 3rd quarter. Our $947,000,000 real estate portfolio contributed $14,700,000 in net rental income in the 2nd quarter and continues to be mainly comprised of net lease properties with long term leases to investment grade rated tenants. We sold 4 properties for a net gain of $3,400,000 during the quarter, including the 2 REO assets previously mentioned. In conclusion, we maintain ample liquidity, a strong balance sheet, conservative leverage and a well supported dividend, positioning us to seize opportunities as 2024 progresses. With that, I'll turn the call over to Paul.

Speaker 2

Thank you, Pamela. In the Q2 of 2024, Ladder generated $40,400,000 of distributable earnings or $0.31 per share of distributable EPS for return on average equity of 10.2%. Our earnings in the 2nd quarter continued to be driven by strong net interest income and stable net operating income from our real estate portfolio and was complemented by gains from sales of real estate properties. As Tom will discuss, the unsecured bond issuance that priced at the end of June and closed in July further strengthens our balance sheet. Ladder issued $500,000,000 of unsecured corporate bonds at 7.0 percent with a 7 year term, which is callable after year 3 in 2027.

Speaker 2

Unsecured corporate bonds are the foundation of our capital structure with now $2,100,000,000 outstanding across 4 issuances. Pro form a for the issuance, 91% of our debt is comprised of non mark to market financing with 53% of total debt being unsecured corporate bonds with a weighted average maturity of over 4 years and an attractive weighted average fixed rate coupon of 5.2%. We remain committed to the corporate unsecured bond market as our primary source of financing and are now the closest we have been to an investment grade credit rating than at any point in Ladder's history. As Pamela discussed, both Moody's and Fitch placed Ladder on positive outlook and Moody's upgraded and un notched the rating on our bonds to BA1, aligning our bonds with our corporate credit rating. Additionally, S and P also issued an upgrade to our rating on both our bonds and our corporate credit rating.

Speaker 2

With Moody's and Fitch just 1 notch away from investment grade and now with a positive outlook on our corporate rating, Ladder is one step closer to achieving our long held goal of becoming an investment grade company, which opens Ladder to the more accessible and broader investment grade bond market, where we believe Ladder will ultimately achieve a more attractive cost of capital and enhance our return on equity to shareholders over time. Our balance sheet remains highly liquid. As of July 25, we had $1,600,000,000 in cash and cash equivalents or $1,900,000,000 of liquidity with our $324,000,000 unsecured revolver, which remains fully undrawn. Our loan portfolio totaled $2,500,000,000 as of quarter end across 85 balance sheet loans, representing approximately 50% of our total assets. We did not record any specific impairments in the Q2.

Speaker 2

However, we increased our CECL reserve by $5,000,000 bringing our general reserve to 54,000,000 dollars or an approximate 213 basis point reserve on our loan portfolio. The increase was driven by the continued uncertainty in the state of the U. S. Commercial real estate market and overall global market conditions. Our $947,000,000 real estate segment continues to generate stable net operating income and includes 155 net leased properties, representing approximately 70% of the segment.

Speaker 2

Our net leased tenants are strong credit, primarily investment grade rated and committed to long term leases with an average remaining lease term of 8 years. As we have historically demonstrated, we have a long track record of maximizing the value of real estate assets that we own and operate. This was demonstrated through the sale of 4 properties, including the 2 REOs previously mentioned that generated a total of $3,400,000 of net gains for distributable earnings during the Q2. As of June 30, the carrying value of our securities portfolio was $481,000,000 99% of the portfolio was investment grade rated with 86 percent being AAA rated. As of July 25, our entire securities portfolio was unencumbered and readily financeable, providing an additional source of potential liquidity, complementing the $1,900,000,000 of same day liquidity as of that date.

Speaker 2

As of June 30, 2024, our adjusted leverage ratio was 1.4 times and has continued to trend down as we delevered our balance sheet while producing steady earnings, strong dividend coverage and a double digit return on equity in the Q2 of 2024. As of June 30, our unencumbered asset pools stood at $3,100,000,000 or 62% of our balance sheet. 82% of this unencumbered asset pool is comprised of the 1st mortgage loans, securities and unrestricted cash and cash equivalents. Our significant liquidity position, large pool of high quality unencumbered assets and capital structure that has been further strengthened with a new corporate bond deal provides Ladder with strong financial flexibility as we head into the second half of twenty twenty four. As of June 30, Ladder's undepreciated book value per share was $13.71 which was net of the $0.42 per share of SeaSource we have established.

Speaker 2

In the Q2 of 2024, we repurchased $212,000 of our common stock at a weighted average price of $10.75 per share. Year to date through June 30, 2024, we have repurchased $860,000 of our common stock at a weighted average price of $10.77 per share. Finally, our dividend remains well covered and in the Q2 we declared a dividend of $0.23 per share, which was paid on July 15, 2024. For details on our Q2 2024 operating results, please refer to our earnings supplement, which is available on our website and Lattice's quarterly report on Form 10 Q, which we expect to file in the coming days. With that, I will turn the call over to Brian.

Speaker 3

Thanks, Paul. We're pleased with our 2nd quarter results, especially because we were able to issue a $500,000,000 unsecured corporate bond with constructive commentary from all 3 rating agencies. The issuance was another important step in our continued quest to become an investment grade company. It also sets the table for us to increase our asset base and grow earnings in the years ahead. With the Fed signaling that they are likely to begin an easing cycle before year end, market optimism has become more prevalent.

Speaker 3

At Ladder, we share that optimism and why not. Our quarterly cash dividend is well covered despite our use of relatively low leverage while having nearly $2,000,000,000 of liquidity providing us with substantial earnings power going forward. Because we are beginning to invest our significant cash position into higher yielding investments at a time when lending in commercial real estate is increasingly falling under the domain of non bank lenders, we think the future looks bright for our shareholders in the quarters ahead. Our loan portfolio continues to pay off at a comfortable pace and even when we've had to take back a few properties, we've been able to sell them in short order generally at a gain to our basis. We still feel like the acquisition of securities offers the best risk reward proposition for our investment dollars.

Speaker 3

As Pamela mentioned earlier in the Q2, we acquired $81,000,000 of AAA rated securities at an unlevered yield of 7.1%. We have continued to acquire additional AAA securities into the Q3. We also purchased a minority interest in a Class A office building in Midtown Manhattan for $13,000,000 Our purchase price was at a price of just under $3.50 per square foot. Our investment was made just a few weeks before news of JP Morgan's agreement to purchase 225 Park Avenue for $5.75 per square foot was a likely plan to tear it down and build something modern. The two assets described are just a 5 minute walk from each other.

Speaker 3

The Plaza District around Grand Central Terminal in Manhattan is bucking the trend in the office sector with financial services companies like Ares Capital, Black Stone, Citadel and JPMorgan making major long term commitments to this vibrant pocket of real estate and we hope to benefit from this momentum with our recent purchase nearby. The expectation of lower interest rates has given way to a sense that commercial real estate in general may have bottomed in the last 6 months. While office will be the slowest to recover, overall, there is a sense that the worst may be over at this point. There will certainly be more foreclosures and properties changing hands, but green shoots are showing up in many places. We've even seen politicians in Philadelphia and San Francisco calling for workers to return to office in person, creating safer streets.

Speaker 3

It's become apparent that hollowed out downtown business hubs ultimately caused deficits in municipal budgets and residents in many of the hardest hit places are increasingly calling for new leadership that prioritizes their safety and well-being. While the mood of the market seems to have improved lately, caution is still warranted because liquidity is thin and can become almost non existent very quickly without warning. Despite new supply being on the low side for years now, credit spreads in CMBS and commercial real estate CLOs are still wide by historical standards. That's why we like buying them, but we generally keep to the AAA classes due to this concern around liquidity. Increasingly, we are seeing the actual rate on a new mortgage, especially on larger dollar amounts being set by the public markets and not by a bank lender.

Speaker 3

By taking the bank out of the risk position relating to spreads, the larger investors and securities have a lot to say about what rate a borrower should pay if they want these large buyers to buy their bonds. This new way of setting mortgage rates after the securities have been placed on order will probably be around for a while, but this shift in pricing power to the buyer of the securities away from the bank lenders is resulting in spreads staying wide at least for now, despite a general lack of supply. On short T bills with rates in the mid-5s has also caught the attention of a lot of these investment dollars dampening demand for mortgage bonds. But keep in mind, it's possible that the holders of the losses stemming from mortgage investments in the last decade of lower interest rates may now be involved in determining the mortgage interest rate for sponsors seeking to borrow against commercial real estate. Loans secured by unusual property types or relating to a large cash out refinancing or loans to sponsors that have walked away from other properties have been seeing wide pricing after the deal is first introduced to the market.

Speaker 3

That's a new development. So now that the first half of twenty twenty four is in the history books, we can probably look forward to some much needed relief in the second half with rates expected to fall in the quarters ahead. With a large cash position, low leverage and a strong credit culture, we feel that our differentiated funding model has us in an enviable position to take advantage of the investment opportunities ahead. We can now take some questions.

Speaker 2

And our first question comes from the line of Stephen Laws with Raymond James. Please proceed.

Speaker 4

Hi, good morning.

Speaker 3

Hey, Hamil, I want to

Speaker 5

hey, Brian. I want to start with the investment pipeline and focus on offense. And I know you guys both touched on the security purchases. And Brian, I think you mentioned those provide where you're seeing most attractive returns. But given the leverage, you don't get a lot of capital deployed there.

Speaker 5

So if you think about moving on offense in the second half of the year, when do you see kind of new loan investments accelerating? Is that a 3Q event or is it going to take time to kind of get the pipeline origination activity restarted and more 4Q growth on the loan portfolio? And when you look at what are you looking at there? Are you looking at maybe helping fill the void in construction financing? Are you looking at possibly mezz loans?

Speaker 5

Kind of how do you think about turning the loan originations back on?

Speaker 1

So, hey, Steven, it's Pamela. A couple of things, I think you asked a lot of questions there. On the securities portfolio, I just want to be clear. Right now, our securities portfolio is unlevered. So we actually are deploying cash and it's really quite competitive with the returns on loans right now.

Speaker 1

It's over 7 percent unlevered. And given our cash position, it's a nice complement to that. On the loan portfolio, listen, we are actively looking at loans. We are not waiting to go on offense. We're waiting to see the right opportunities to deploy our capital.

Speaker 1

Given the fact that we are covering our dividend well and we feel comfortable with our credit, we're looking to add accretively. So I do think we're starting to see the pipeline build. We closed alone this quarter. We have loans in pipeline. But realistically, I think you've got to see some momentum in the Q3 and we're hoping it will really rev up in the Q4.

Speaker 1

Great. I think that answers the question.

Speaker 3

That's fine. And Stephen, I just want I'll add, don't plan on getting into construction lending.

Speaker 6

It's

Speaker 3

not a forte of ours. And but we do there's just not a lot of demand right now. And the interesting part, as I mentioned, is that volume has been quite low in production and not just at Ladder, but also in the CMBS world or the CLO world. The Wall Street Journal published, I don't know, it's about a decade chart of CMBS and single asset deals. And single assets are up because they're usually big sponsors that have to borrow.

Speaker 3

But the volumes have been well way down since 2017, 17, 2018. And you would think normally that would create a supply problem. I mean, a lack of supply would create a pricing difficulty because it would be very tight, but in fact, the opposite is true. They're quite wide. In fact, mortgage spreads are nearly as wide as I've ever seen them.

Speaker 3

And that doesn't make a whole lot of sense, but I do believe it gets pushed wider by T Bills, as I said, in the mid-5s. And also the fact that the public you've actually very quietly shifted how mortgage interest rates are made, what like who sets the rate. And we used to avoid large loans in big cities because there frankly were too many lenders. And I felt like we didn't really stand a chance at least hitting the hurdle rates we wanted to hit because a lot of lenders were making loans to accommodate clients. That's not happening anymore.

Speaker 3

What's very no one announced it and nobody sent anybody an email, but the markets are now setting the rates on mortgage deals at the closing. So what they'll do is they'll go out and suggest to the market a structure with a rating agency input and then the market sets the level. And right now the market just thinks that commercial real estate should be pricing wider. So we have been picking up as I think we said over $80,000,000 in the Q1, we're well over $100,000,000 already this quarter in just the first half of July. And these yields, unlevered are in the low 7s, at 175 to 210 over, which is hefty spreads.

Speaker 3

If you lever those, they lever into the 20s. And, but the way I think envision this is given the fact that we just raised a lot of capital and we already had a lot of cash, we'll travel in an unlevered state for a while. And then as we run out of or run those balances down, we'll start levering, not all of them, we'll lever half of the securities. And that should get us into a pretty comfortable well above dividend rate. And when you think about the liquidity and the financeability of those bonds relative to a whole loan at 250 or 300, to me it's a superior investment I think and then I think we're going to stay in that area.

Speaker 3

And the other part is we're not missing anything. There's no volume anyway. There's just not a lot of demand. You'll hear this from banks, competitors, everybody. And rates are just quite wide.

Speaker 3

And there's plenty of people looking to refinance assets, but you wind up in the equity by accident on a lot of those. And on an acquisition, there's a lot of people chasing those, So they're quite tight. But I am very happy to be buying AAA's at 200 over rather than selling them to people at 200 over.

Speaker 5

Appreciate the color there. As a follow-up around the dividend, incredibly strong coverage now. It seems like the outlook as you move to offense both out of cash and those higher yielding securities and loans and then eventually leverage probably sometime next year. That coverage likely only continue increasing. So when you have your discussion with the Board and you look at the dividend, it's like a 6 handle yield on undepreciated book value.

Speaker 5

What are the considerations that go around when the right time to increase that dividend or if increasing it's the right way to go? How do you think about setting the right level for the dividend moving forward?

Speaker 3

Well, it's higher dividends follow higher earnings, especially in a REIT that distributes 90% of its income. So, one, the earnings will come first and then the dividend will follow. But if you just take a look at the cash holdings on our balance sheet right now, if we simply lever that 50% and you can easily see how our asset base can get a lot bigger, it can go up $2,000,000,000 to $3,000,000,000 and that will create tremendous earnings power. So if we're out earning our dividend while holding almost $2,000,000,000 in cash, it shouldn't be a big step to start thinking about raising it as we get through the tail end of the downturn and also the beginning of what I would call the expansion.

Speaker 5

Great. Appreciate it, Thomas, this morning, Brian. Thank you.

Speaker 3

Yes. Thank you.

Speaker 2

And the next question comes from the line of Steve DeLaney with JMP Securities. Please proceed.

Speaker 4

Thanks. Good morning, everybody. Look, congrats on the new bond issue and all that, that implies and also just a very solid quarter all around.

Speaker 2

So look, I think

Speaker 4

we Brian, we've got more clarity now on the Fed, the outlook for the next couple of years. And if we get 50 basis points this year, 100 next, something in that magnitude, how impactful really is this to the overall CRE market? Obviously, that's short rate, but you got to figure the longer intermediate rates will be impacted by the Fed's actions. Will that rate environment over the next 15, 24 months, is that going to bring fresh equity, institutional equity off of the sidelines into CRE? And isn't that what you need to be able to you need equity to come in the market so that creates new transitional bridge loan opportunities?

Speaker 4

It just seems like the problem is there are not enough borrowers even with the banks falling back and stepping away. Just curious how that plays out for Ladder competitively in a lower rate environment? Thank you.

Speaker 3

Sure. Well, I think the first step there is transaction volume will increase because more dollars will go to the equity holder than the lender relative to today. So that would be chemistry class A. Just the 1st year you would want to see transaction volume pickup. If transaction volume picks up in there, there's plenty of equity around.

Speaker 3

I mean, as we mentioned, we sold I think 4 properties in the quarter. Typically, we think about selling it and then the phone rings and before we have an auction going on. And it's oftentimes people who have been looking at the asset, but not talking to us, they've been talking to the prior owner. And we may be a little bit guilty of basis trading because I do think some of these are pretty cheap. But I think first step is lower rates and just the jawboning of lower rates has already created a bit of an optimistic feeling in the market that you might remember from January when we were at Cresty down in Miami, everybody is thinking 6 to 8 cuts and they were ordering the expensive Cabernets again.

Speaker 3

That all fell apart pretty quickly. But this time, it kind of looks like we're at the end of the Fed cycle and it looks like they're going to embark on a lower rate cycle going forward because they seem to have I've never thought they were going to get to 2% inflation. I think they're at 3% and I think they're going to live with that. And but then on the other hand, they now have a dual mandate. So they've got to watch I mean, they've always had a dual mandate, but they tend to only focus on 1 at a time.

Speaker 3

But as the economy is undoubtedly slowing a little bit and I think you'll see that as they get a little bit more concerned about participation in the job market and juxtaposed against the 3% inflation rate, I think they'll start instead of fighting with inflation, they're going to make sure they don't create the jobs market. So yes, we do need it to happen and it's always easier. I've been doing this for a very long time and when stock markets are plumbing new highs, invariably somebody sells some stock that have a big gain and they move over to buy an apartment building. So, real estate travels with a lag factor behind stock market. And the stock market continues to levitate.

Speaker 3

Most of the stock market valuation took place because of compression of multiples as opposed to actual earnings gains. So we'll see how they sort it out here. We're a little concerned about volatility. You saw the VIX yesterday go above 18% very quickly. So not out of the woods here and that's almost like my reference to liquidity and how quick it can vanish.

Speaker 3

I mean, when the VIX goes from 12% to 18% on nothing, that's a little concerning. So I think we're going to continue to be conservative in our approach. And as long as AAAs at 175 to 200 are out there, we'll let other people do the lending for a while and we'll buy the finished products. But once things stabilize and I think the Fed will steepen the curve, you saw

Speaker 4

a bull steepener go on recently, but I suspect the 2 year will fall more than the 10 year will rise. And once that happens, that's when the real estate market really does start catching on. And real quick follow-up. You did this JV interest in a partnership. Could we see a transaction where you saw a building, you and other investors created a partnership, bought the building, it needed to be rehabbed or whatever.

Speaker 4

Could you put equity into a project and also make the bridge loan to the partnership? Would you do you get 2 bites at the same apple? Sure.

Speaker 3

I'll even offer a 3rd bite. There's a scenario where you stretch a senior and you basically make your equities a debt instrument, sometimes we call it equity internally. And instead of just owning the real estate with the partner because all of your investment dollars are senior to his, then you just put a rate on it. So you combine a senior with a mezz and you take a participation in the building. So there's 3 versions of it.

Speaker 3

1 is, yes, we could be a lender to the partnership. 2, we could be an equity borrower in a debt outfit with a higher stretch on the size of the loan or else we could just be equity in the deal and borrow from somebody else like we just did.

Speaker 4

Thank you very much.

Speaker 2

Sure. And the next question comes from the line of Jade Rahmani with KBW. Please proceed.

Speaker 3

Thank you very much.

Speaker 7

You all have been sitting on ample amount of cash for quite some time and are in an enviable position versus competitors, yet originations were pretty subdued in the quarter. So I'm wondering if you feel that the market is actually in fact too competitive with debt funds chasing a very limited pool of deals? For example, CBRE showed commercial mortgage originations up 38% and they said debt fund volumes were up 70%. Isn't the markets too competitive actually?

Speaker 3

The market, that's a big word and it covers a lot of ground. But the addressable market, in our opinion, not exclusively, but largely lands in borrowers seeking debt on acquisitions. So you just got rid of 75% of the addressable audience. And if it's a multifamily, then it's too competitive. Yes, I think it is for but it isn't too competitive because of too many competitors.

Speaker 3

It's because there's really no volume. But you're seeing the market react and it is the purchase that we made during the quarter of an office building. That was that's a reset on price. And as you see more and more of that happen, you'll see more and more acquisitions. So, I don't think it's too competitive.

Speaker 3

I think there is just a lack of demand when there is a high quality investment possibility on a lending assignment, it is very competitive, but it's not like they're losing money. I don't, it's not that bad. But what is happening, I think is that a lot of volume is being driven by the sake of transacting as opposed to margins or making a lot of money because I don't really understand how you make money lending at 2.50 to 2.75 over SOFR and then selling AAA's at 190 to 200. And you would think with a lack of supply like you just mentioned, there is this tremendous widening going on in the securities market because I just believe the pricing mechanism is inefficient. And for the first time in my career, we're seeing the price of the interest rate on a mortgage is being set by the public markets, not by a banker who's taking a risk.

Speaker 7

On the origination side, could you say as to the volume of term sheets you put out and the success rate you're hitting? I'm just trying to gauge competition if you're really actually losing out

Speaker 6

on a lot of deals.

Speaker 3

We're not losing out on when we bid on something that we like, we are losing some of course, you always do, but not at a in fact probably at a lower clip. Where we're seeing fallout take place is you've got a lot of new buyers coming into the market who have been pretty good stewards of capital through the last decade and didn't really lever up on low interest rates. So they're now acquiring assets at lower prices because of the reset. And many of them have never seen documents from CMBS shops or CLOs. And so they're bank lenders primarily.

Speaker 3

And when they see our documents, they're like, oh, this is scary. And so sometimes they just step away or sometimes the rate is so high that they just funded all cash even after we send the term sheet out. So there's a myriad of reasons why, even the small volume that we are sending out isn't really coming back with productive situations, but it has little to do with competitors at lower rates. It's more nuanced than that.

Speaker 7

Okay. Just in terms of property type mix on the loan portfolio, office increased to 34% from 30 1%. And I think that you probably are seeing repayments proportionately outside of office. There's probably some office, but maybe more in the other asset types. Are you at all concerned about the increased concentration in office?

Speaker 7

And do you maybe provide a comment on how you feel about the office portfolio?

Speaker 3

Sure. Well, multifamily is the easiest thing to pay off. So we are seeing that and obviously office is the hardest thing to pay off. So you're naturally selecting to hire as you take $1,000,000,000 in payoffs over a year. The office sector is not punching above its weight in the portfolio.

Speaker 3

What we do particularly like about us though is that our office buildings loans, we look at every loan, never mind office or multifamily as if we're getting it back. And if we're going to get it back, we want to know what we're going to do with it. I think you will start to see, 1st of all, in the CMBS world, a lot of office is going into those deals. They're going in at very non courageous debt levels, but makes sense, but it used to be you couldn't put an office loan in. Now it's probably the highest concentration of property type.

Speaker 3

And I do believe it's because of these resets that are taking place. But the way we approach our office portfolio, we've been triaging some of these for a couple of years and our sponsors are hanging in for the most part and they're paying it down and we're deleveraging these situations. So every time a borrower writes a check for $5,000,000 in principle and buys a cap for $1,000,000 and posts reserves for TIs and leasing commissions, you just sort of think, Barry, that's probably not going to default. And we are seeing quite a bit of that, the vast preponderance of effects in our portfolio that's happening. Where probably the most dangerous part of the portfolio would be in large cities, where there is still difficulty with many things, never mind just real estate, but return to work is slow, Washington D.

Speaker 3

C. Is a horror. But we did have a couple of loans, but they're quite small in cities that they were very not well occupied buildings and they're still not well occupied. And so we may very well get those back, but they're quite small and the loan amount that we committed to never got to as big as we had committed to because for the most part, it was a poorly occupied building that is still poorly occupied. It's just in much better shape now.

Speaker 3

So there's we'll get a few of them back. I'm not signaling that we're going to run through this without a problem, but we haven't taken losses yet. And that is a little surprising to me. I think we're well covered by our CECL reserve. I don't really see anything on the horizon.

Speaker 3

And we're kind of at a point now too because we didn't write a lot of loans for a while there. We're getting to the point where we understand every loan in the portfolio and where the problems may come from. There are borrowers who tell us they're going to give us the keys and then they don't. So it's a little hard to predict that. But for the most part, we worry about basis and as evidenced by the fact that we went out and bought an office building and rather it wasn't a foreclosure.

Speaker 3

It wasn't we had no relationship to it prior to that. We just thought it was cheap. And so we're happy to step out of our typical suit and do something a little different. And we're not overly concerned about our office portfolio. When I say not overly concerned, I don't see us getting through a $50,000,000 CECL reserve, unlikely.

Speaker 2

And the next question comes from the line of Tom Catherwood with BTIG. Please proceed.

Speaker 5

Thank you and good morning everybody. Maybe Pamela or Paul, appreciate the commentary in your prepared remarks on Moody's and Fitch's outlook for Ladder. What are the next steps or hurdles that the rating agencies are looking for as you progress toward investment grade rating?

Speaker 1

I could start and Paul feel free to jump in. The short story is we have met the objective. They have objective tests and we met them already with the last issuance, which is why I think you saw some positive on us. I think we made it really difficult for them to do nothing. We would have liked to have achieved the investment grade rating when we hit the hurdle.

Speaker 1

But given the market backdrop in commercial real estate, all the agencies were reluctant to do anything too aggressive in terms of an investment grade rating in this environment. So if you ask me with a lot of knowledge, I can tell you, I think if we continue to perform, we demonstrate what Brian said earlier, we have real confidence in our CECL reserve, which is currently $54,000,000 We think that should be more than ample to cover any potential losses we may incur. As we turn the balance sheet, the market moves out of this state of distress and we start to see rates come down. I think with the next issuance, we are very hopeful to see an investment grade rating. Paul, is there anything you'd want to add to that?

Speaker 2

Paul, as we mentioned in the remarks, 53% of our liabilities are now unsecured corporate bonds and we're well over 50% in other words in utilizing our secured corporate bonds and our liability structure. So as Thanos said, quantitatively within the hurdle, it's really a matter of the Siri backdrop that we think is the biggest hurdle.

Speaker 5

Understood. Appreciate those thoughts. And then last for me, maybe Brian, given your comment earlier that you're happier to be acquiring securities at $175,000,000 to $210,000,000 over rather than originating them. Is it likely that activity on the conduit side of the business could remain more muted in the near term?

Speaker 3

Likely, I think. And you'll really see the first sign of a thawing out in that business will be when you don't have 13 originators each putting in 3 loans. That's a pretty unusual roster of originators. And that just tells you they don't have enough size or demand to go it alone. So they're combining forces with a lot of other lenders.

Speaker 3

But I think the CMBS business will pick up when you see a steepening of the yield curve. Because if you write a 10 year loan off of a rate that's lower a base rate that's lower than the 2 year, you have to hedge that. And when you start hedging a 10 year that's below the 2 year, you start there is no carry in the business pretty much. And it is a substantial component of profitability when that business is functioning properly. So I think the as the Fed cuts rates, the curve will steepen and that business will pick up.

Speaker 3

It will start in the 5 year category and it will progress to the 10 year

Speaker 2

And our next question will come from the line of Matt Howlett with B. Riley Securities. Please proceed.

Speaker 6

Yes. Hey, thanks. Good morning. Just to follow-up on the investment grade rating. What do you think it will save you?

Speaker 6

I mean, in terms of I know there might be once you get it, there might be a lag in terms of the yields on the new debt that you issued, but just sort of what do you think you could do debt at? You did what 7% on the 7 year debt. Just curious on what do you think will save you ultimately?

Speaker 3

Yes. Pamela, you can take it if you want, but I would just say the first one probably not that much because you're kind of new to the space. But because we've done 7 issues at this point, never know. But if I were and I'll listen to Pamela and Paul, they may know better than that, but I would quickly cup it at 200 basis points in the beginning and maybe 300 at the end.

Speaker 1

I think it's a little less than that on the crossover credit. I think we were hoping to build into, but on the first crossover credit when we the next issuance, we would hope to save at least 50 basis points. I think for us, Matt, it's a longer term play. We think that there's a real spot in the world for a mortgage REIT with primarily basically exclusively at this point senior secured assets delivering a high single digit, low double digit return. And the reality for Ladder is given our high insider ownership and internal management, we have consistently run this company since we opened the doors in 2,008 with leverage of 2 to 3 times.

Speaker 1

So it is not that is the leverage constraints we'll be living with. The only difference will be that we'll have a higher component of unsecured debt, which in this environment we think has proven to be not only, safer, but accretive at a time like this. I think we have the lowest cost of funds on the street right now. So for us, I think the way we think about it is we will have long term savings and we're also very we're looking forward to trying to convert traditional equity REIT investors because we basically check every one of their boxes in terms of internal management, insider ownership, low mark to market debt and the investment grade box is really the only box we don't check. We'll be a little bit constrained by we're not obviously going to be a huge growth company, but we think that there'll be a big appetite for us.

Speaker 1

So we don't think we'll just see it on the debt side. We think we'll see a conversion of our institutional and retail ownership on the equity side as well.

Speaker 3

What I'd also add, Matt, is you have to watch flow of funds and like where things are going. Right now, the high yield market is not charging a lot of premium because there's not a lot of defaults. But if you just look at the ETFs like JNK and LQD, it'll give you an idea of the differential. Although because we're in the commercial real estate business today, we trade on the wide end and because we're not a single B, we probably are more towards the middle of a high yield index. On the other hand, if we and that's a 4 year, it's not a 7 year on average.

Speaker 3

But if we were to go to an investment grade credit, the LQD is dividending a little over 5%. So it's maybe aggressive. It's hard to say, but the first time you go, you'll learn a lot and you'll probably not get the rate you want because you'll look at the index and they're going to say you're new, we're penalizing you. So they will. However, in the long term, the high yield market is the size of the corporate bond market in the investment grade is massively higher than the junk bond market.

Speaker 3

So you've got a much bigger group of people and they tend to own the same names over and over and nobody owns us in the investment grade space. So it's a lot of factors that go into it, but I still think you price wide the first time and then after that you do better.

Speaker 6

Well, it's clearly going to put you in a stronger position. We already have the best probably best balance sheet in the space right now. And I guess where I'm going with this is, I mean, we see all the news, we see your peers, big and small, having issues, Brian. I mean, at what point do you think you'll at what point would you get aggressive? Do you see deal are you getting calls from bankers looking at maybe taking something over time?

Speaker 6

I mean, do you want to make a splash? Just I mean, you got to obviously tons of cash, tons of liquidity and there's a lot of peers struggling. And there's obviously could be a lot of flow coming out of the banks over time. We keep hearing that. But what about making a splash?

Speaker 6

I mean, are you saving the capital for

Speaker 3

that? No. The latter is not a flashy company at all and not at all interested in making a splash. Far more interested in just developing attractive return profile safely. We don't like big flashy buildings, we don't like big flashy companies and we don't like high leverage, which makes us a little unique in the REIT space.

Speaker 3

So no, we're not saving it. We just think there's a big opportunity coming, but we'll probably stick to our knitting. The only thing I would tell you that I think is developing is if you have a $20,000,000 loan, you can refinance it. Yes, I mean there is a place you can go. You may pay more than you want to, but it's not like it can't be done.

Speaker 3

And if you have a $350,000,000 loan, you can go to one of the big banks and have them take it to the rating agency and they'll take you to market and the market will tell you what your rate is. But if you have an $80,000,000 or $90,000,000 loan, you're sort of in this air pocket between too big for a bank and too small for a single asset deal. So I think that $70,000,000 $80,000,000 $90,000,000 area is a very, very attractive place for somebody who wants to commit capital without going to with the certainty of the capital markets spreads. So to me that's an inefficiency that has bubbled up here that I think will stay there for a little while. The trick to that though is if you want to start writing $80,000,000 loans to securitize them, you can't write 2 or 3 of them.

Speaker 3

You have to write 10 or 20 of them. And therein is the rub. But I think if the volume picks up and transactions, building start getting. So I think we might very well go into that kind of a space and acquire $1,500,000,000 $2,000,000,000 worth of loans and do a single sponsor securitization where we hold the BPs because we know all the credit and go sell the bonds to the public. But we would have the rate on the mortgage definition because it won't all close on one day.

Speaker 6

Got you. And just to follow-up on that, one of your newer peers came out and sort of said, there's got to be the secondary market supply. Let's just say, I don't think he's talking about securities as much as he's talking about just senior loans as Ford and Ed saying levered yields are between 12% 16% and we've raised upfront and rededicated just to taking all this stuff down, presumably mostly from the banks over the next few years. Do you see that, like that secondary market opportunity where banks just capitulate due to new capital rules and you see these levered yields in the mid tier?

Speaker 3

Yes. I mean the banks are under a lot of regulatory pressure. So that part is true. And but I would just say that a bank selling loans probably with some financing generating a 12 to 16, that's fine. But why would you do that if you can make 20 to 25 on a AAA?

Speaker 3

Right. With leverage obviously, and the safety of being able to sell it pretty in most markets pretty quickly. So I don't think I would steer ladder towards taking a risk at 12%, 13% on a bank sale. I would prefer we move into the safety of AAAs. And as Pamela said, we're not levering them right now at all.

Speaker 3

So yes, we have a lot of cash and yes, we have a lot of liquidity. We also have a few $100,000,000 of unlevered AAA's too, if we feel like generating some cash. The key for us at this point has been to keep the balance sheet fortress like and investors gravitate towards strong balance sheets during difficult times. But as it airs itself out and you get a little long in the tooth in the cycle, these yields will compress. I don't believe we're going to be talking about AAA at 200 over or 190 over for much longer.

Speaker 1

And we have been hanging around the hoop of our originators are actively talking to the banks and we're watching anything that is or will be coming for sale. We are we will be looking at and considering it in the context of what Brian just said.

Speaker 6

And these AAA, I mean, just living through the financial crisis and not everything was AAA that they said was AAA. These are real AAA's, they have like 20% subordination. I mean, they have I

Speaker 3

mean, what Some of them have 50% subordination.

Speaker 6

This is just incredible.

Speaker 3

Well, interestingly, what goes on in the CLO market is as loans default, in which they're picking up the pace there, if the sponsor is in good shape, he pulls them out of the deal and it looks like a payoff. So bad is good unless you own it at a premium. But if you can buy them at 99 and get paid par on a defaulted loan, that's very attractive. So I would say the in the CLO space, the subordination level starts at 40%, 45%. Percent and if you get through a few payoffs or defaults, you quickly get to 60% or 70% subordination and they're still trading very wide.

Speaker 6

That's incredible. I mean, I hope these yields stay around for a while, but like you said, I don't think they will. I mean, it seems like if we I

Speaker 3

don't either, but yes, we're very good at taking what the market gives us rather than forcing our opinions. So, yes, we can live a long time. We don't need the market to tighten. We don't need to lever them. But if the market does tighten, we'll sell some and maybe we'll lever some others when we need to.

Speaker 3

But the best time to borrow money is when you don't need money. And I think in our supplement on our website, if you want to just get the picture that sold all the bonds, it's on page 5. It's a snapshot of us last year and this year. And when we looked at the rating agencies, they were saying it's very difficult market and we said, yes, look what we did in that market. Let's go back a year.

Speaker 3

And we took $1,000,000,000 in payoffs and we delevered the company. We raised a lot of cash. So that's experience. We've been out in bad weather before and we saw it there for what it was and we're not out of it yet. We still think there's a little bit left in this downturn, but I think we're past the most dangerous part.

Speaker 3

I don't think we'll be surprised by anything at this point.

Speaker 6

Look, you've been right all along, Brian, on this. So I got to give you credit. We're definitely paying attention to you when you give out that when you call bottoms like this and start talking about things that we I certainly pay attention. So I really appreciate all the color and comments.

Speaker 3

Yes. I mean, if you think no one's ever going to an office again, probably we might have something wrong here. I don't believe that. I don't think it's ever going back the way it was. I don't think people are going to be charging off the beaches in the Hamptons at 3 o'clock on Sunday to get to work on Monday.

Speaker 3

But, if you're only in the office 4 days a week or you still rent the office. And the main difference in the office space isn't that you can't rent it. You tend to have to pay a lot for a tenant. But in most of our office loans, the buildings are being leased and they're being leased at rents that were higher than we underwrote. The biggest problem is they're not fully leased.

Speaker 3

There is a lot of cost involved in a tenant acquisition to get them in the building and the ROE is just poor. And when you ask them to go buy a cap at 1% or 2% when the prevailing SOFR rate is 5.30%, it gets very expensive. So I think what you'll see and not just with Ladder, but you'll see this with a lot of other people too, they're going to be taking buildings back that are they're doing okay. They're not empty. And there's some cash flow.

Speaker 3

It may not be perfect, but it wouldn't signal a large loss either.

Speaker 6

Well, you certainly made a great call in New York City. You were one of the first to call that. So congrats on the

Speaker 3

You can feel it, right? I mean, New York City is doing better. And if you walk around that area of the Plaza District, north of Grand Central on Park Avenue, that's doing just fine. And when I say fine, I mean there is massive expansion going on there. And so the idea that I don't think JPMorgan is buying an extra building next to its headquarters because they think the office market is going south.

Speaker 6

Great. No, not at all. I really appreciate it.

Speaker 3

Sure. Thank you.

Speaker 2

Ladies and gentlemen, there are no further questions at this time. I'd like to turn the call back to Brian Harris for any closing remarks.

Speaker 3

Just end by saying thank you for hanging with us, especially thank you to the bondholders that purchased our recent offering. We won't let you down there And we hope to be revisiting that space down the road in an investment grade outfit. So thanks again. And yes, see you soon. Bye.

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Earnings Conference Call
Ladder Capital Q2 2024
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