Introduce yourself? How do you want to do this?
What time we got now?
We're green.
We are. Okay, great. Hello, everybody. Thank you all for attending this brief presentation. My name's Mike McGillis. I am the President and CFO of Claros Mortgage Trust. By way of background, Claros Mortgage Trust is an externally managed commercial mortgage REIT. We are managed by an affiliate of the Mack Real Estate Group. Mack Real Estate Group is a diversified participant in the commercial real estate space. We have a lending platform, a development platform, and we also buy existing assets, and we have an asset and property management platform as well. So we are sort of a vertically integrated owner, operator, lender, developer, and we believe that these operating capabilities, development capabilities, give us sort of a unique view into the commercial real estate world and the assets that we lend on within Claros Mortgage Trust.
With that, I'll turn it over to Rick.
Terrific. Hi, I'm Rick Shane. I'm with JP Morgan. I'm an equity analyst. I was thinking about this as Mike was speaking. I've been following the space since December 2002, when we initiated on Anthracite Capital way back when. So, in the spirit of a little bit of perspective, I think we probably bring that as well. No one's here to listen to me, so I'm gonna get right into my Q&A with Mike. Mike, let's start at really a high level. Can you tell us sort of on the front lines, what's going on in the market right now? The one thing that I'm curious about as an equity analyst is, kind of, the how are the challenges at this point distributed across the portfolio?
Is this an 80/20 issue, where you're spending most of your time on a few issues, or are the challenges sort of more homogeneously spread across the portfolio at this point?
Yeah, I would say it tends to be across the portfolio 'cause we're a transitional lender. So the way to think about it, the life of a real estate asset is you can broadly break it up into four different components. One is land, raw land, or pre-development assets. Construction assets, or assets that are being built. Stabilization period, which is from the time the asset is delivered until it is leased up, stabilized, generating a more stable level of cash flow. And then you have the sort of more stable asset period of its life. So as a transitional lender, we're participating in the first three stages of those life cycles. So we are. Our asset management activities are. We're very involved in all aspects of asset management 'cause these are assets in the early stages of their life cycle.
So it, you know, it's not like we're setting and forgetting on a bunch of loans because of where they are in their life cycle. But so we are spending a lot of time trying to stay ahead of where borrowers are in the execution of their business plans, anticipating issues, either at the borrower level or the property level, based upon stresses borrowers are experiencing, which are significant in this environment because of SOFR going from essentially 0 - 5.35 over the last 18 months. It's put a lot of stress in the system with our borrowers. And then uncertainty as well around interest rate environment has really slowed down capital markets activity because typically, we get paid off on loans.
As assets get nearer to stabilization, borrowers can refinance us out, or they're gonna sell the asset at a gain and use those proceeds from the asset sale to pay us off. So that, the higher rate environment has really dampened level of repayment activity, which I think we've seen across the space over the last 18 months.
Got it. Well, and the last time we saw each other was down in Florida in November, and one of the conversations we had was sort of discussing the fact that the commercial real estate life cycle, credit cycle, is a lot longer than it is in other sectors. And I cover consumer finance, where it can be a 6-month, 100, you know, 2 or 1-year cycle. One of the experiences that I took away from the GFC is understanding the duration of both the good parts of the cycle and the challenging parts of the cycle. If you were to put sort of a timeline on how long the cycle lasts how would you define that, and where do you think we are at this point?
It's a very good question. It's I feel like we're into the cycle. We're starting to have visibility into repayments activity within the portfolio, but I don't—I'm by no means irrationally exuberant about where we are. We've got to be realistic. The higher-for-longer rate environment is putting a lot of stress on borrowers, it's putting stress on valuations, and it's putting stress on the ability of borrowers to refinance assets. So I would say we're, you know, if I would put it in baseball context. I'd say we're probably somewhere between the fifth and seventh inning, depending on the market and depending on the asset class. I think we've got a ways to go to work through where we are in the cycle, but like I said, it's very asset-specific and market-specific .
Got it.
There's, you know, like everything, it depends.
I often wonder on Wall Street what would happen if we didn't have the innings metaphor to describe timelines, so I appreciate that, and I think it's context everybody around here gets. With that in mind, you know, you talked about higher for longer, and I think the expectations in terms of forward rates, we show a chart in some of our marketing materials where we show SOFR expectations for 2025. And since January, those expectations for 2025 are up 75-100 basis points.
Do you think that beyond the fundamental impact of higher for longer, that that is causing somewhat of a psychological shift in the space, driving some capitulation in terms of borrowers saying: "Hey, I think I could have made it through 2024, but now that I'm looking on funding these loans out of pocket for another 12 months changing how your borrowers are acting?
Yeah, I mean, I think we, we've seen it in limited circumstances where it's affecting borrower behavior. But the longer, the longer the higher rate cycle goes, I think it's gonna be create challenges. However, in a lot of these asset classes, we do continue to see rent growth, particularly like we're 40% of our portfolio is multifamily. We continue to see pretty strong rent growth in the multifamily markets that we're in. So at some point, NOI growth will catch up to baseline interest rate growth, and it makes it, borrowers will get a little more optimistic on that front, or as rent growth occurs and they're looking to, say, put a construction loan in place, the sort of untrended yield on that asset will then justify paying the higher rate for the construction loan.
W e're fortunate we don't have a lot of office exposure. We're only 14% office. That is a sector that's clearly got its own set of challenges. I t's very much borrower specific and if they're looking at a really short-term hold period, it's more challenging. If they have a longer view on the market, they'll typically stick with the asset.
Got it. Okay. Let's pivot a little bit, and this is something you touched upon in your first response. But as we move through the year, one of the most important considerations in managing your liquidity is balancing repayments and fundings on prior commitments. How much visibility do you have on sort of both sides of that ledger?
I think we actually have a fair amount of visibility. I'll start with the future funding. So we tend to have a little heavier construction loan portfolio, just given our background as developers and construction managers, and we leverage those capabilities as we lend on construction assets. So these loans are highly structured, so we have, you know, very good visibility, very active asset management into what's happening at the project level on a day-to-day basis. But we haven't been making new loans just because of the challenges in the market right now. If you looked at our future fundings on our construction loans, there's probably, if you back out items we don't expect to fund, we're probably $750 million-$800 million of future funding commitments.
But we've already got financing in place for about 2/3 of that, and that'll get funded based on construction schedules of those projects. That funding will occur typically over 2-2.5 years. Put that in perspective, the last 15 months were pretty challenging 'cause we started 2023 with about $2 billion of future funding requirements on existing construction loans. So we've had to work through that in a period where we saw significant declines in loan repayment activity, combined with a, you know, more challenging market, where we had to reserve more liquidity to reduce advance rates on certain of our assets that are financed on warehouse lines. So we managed through that. I feel pretty good about that aspect of it. And as I look ahead, the future fundings have come down significantly.
We are starting to see some visibility into loan repayments. Not enough where I'm saying we're gonna start originating loans again, but pretty good visibility that there's a light at the end of the tunnel here.
Got it. And I don't wanna put too fine a point on this, but I wanna make sure that if I'm hearing this correctly, you funded over $1 billion of prior commitments in the last 12 months, and your forward pipeline is $700 million-$800 million over 2.5-3 years. So it's a fraction of what you have funded in the past 12 months.
That is, that is correct. And we also got repaid on some loans or sold some loans that had significant future funding commitments. So it might not have been $1 billion out the door, but it was close to that. And then we eliminated probably $150 million of future funding commitments as a result of loan sales or loan repayments.
Got it. And look, you'll—I sense a theme here 'cause I'm gonna circle back to a question I asked as a follow-up last time. But, has higher for longer, do you think, distorted your expectations in terms of repayments at all?
I think we had a very muted view of projected repayment activity since the rate rise started back in 18 months ago. I think we are seeing the capital markets loosening, loosening up a little bit. We're seeing transaction activity picking up again. Bid-ask spreads are continuing to get tighter. I mean, I'll give an interesting perspective. In our equity business, we're pretty regularly bidding to acquire in-place assets in addition to developing assets. And there was a newly delivered multifamily asset in a secondary market, but a decent market, that recently traded, based on our math, at about a 5.3 cap rate. So there's capital out there. It's willing to transact on high-quality assets. But it's, you know, it's very much gonna be driven by what is the return horizon of the buyers.
Okay. We'll pivot again. Look, I know you're highly aware of this. Your stock's trading at a substantial discount to book. Your term loan is trading at a discount to par. When we speak with equity investors, the question is, why aren't they buying back stock? When we speak with fixed income investors, the question is, why aren't you buying in the term loan? How do you think about those considerations? How do you balance those considerations, particularly in light of the funding commitments as well?
Yeah, so the simple way to think about it is we have available liquidity. In terms of how we use that liquidity, we're gonna make future funding commitments on our existing loans. We always try to maintain a measure of liquidity so that we can reduce leverage on some of our loans that we have by de-leveraging warehouse lines, which is very defensive strategy, but that's how we manage the portfolio. Like, we've voluntarily de-levered about $400 million of borrowings on our repo lines over the last 18 months. W e've got to first make sure we can handle all that, and then we would look to, either de-lever higher-cost borrowings. If the time is right, we have bought back Term Loan B at discounts. In the past, we did such in, second quarter of 2023, modest level.
We view the stock as undervalued. For those that saw management bought into the stock at significant levels last week. We feel like it is significantly undervalued relative to intrinsic value. So we don't necessarily feel like we have the liquidity in the vehicle now to buy back stock, but management has been a significant buyer in the last couple weeks of the shares.
Look, I think that's, I think that's both an honest answer and a, you know, a strong one as well in terms of the management's commitment. One thing we didn't talk about in terms of the hierarchy of capital, requirements or cash, is the dividend. Where does the dividend fall into that spectrum of importance?
Yeah, well, the dividend, you know, we'll look at that every quarter with our board. And we're really trying to set a dividend level that reflects the medium to long-term earnings capacity of the vehicle without factoring in some of the volatility in quarter-to-quarter earnings based on performance of certain of our REO assets and timing of loans going into or out of non-accrual status. So we're trying to look at more of a longer view. It's something that we look at hard every quarter, where we are, where the portfolio is, what are our alternative liquidity needs, and you know, what is and you know, we reevaluate that every quarter.
Got it. And when you take that medium to long-term view, part of, part of the nature of this business, and you guys get this, and you've been transparent about this from the beginning, so this is a credit-sensitive business. Modifications, non-accruals are part of the business. Do you factor in some ongoing level of non-accrual, sort of on an actuarial basis, as you set that policy?
Uh, yes.
Okay.
We would, we would look to do that, and then there may be periods of time, like now, where we may think there's some opportunities to foreclose on assets and improve operating performance beyond what our borrowers have done because of stresses in the borrower system, and that costs money for a period of time. So we try to think about the capital needs associated with that as well, and what the long-term, medium to longer term earnings potential is of that asset, so that we can get it repositioned, get it, get operating cash flow maximized, and then sell out of that asset.
Got it. It's actually a great segue, and one of the things I will observe is that I think when we got to know each other during your IPO process, you guys were very clear that you see one of the core strengths of the company is your ability as operators, and if you see a borrower or sponsor who is not hitting the milestones that you are, I would describe willing to lean into solutions and really make sure that you're exercising your legal rights.
That always stood out to me, and it's interesting to see that as we move through the cycle. As we think about this at a very simple level, there really are w hen a loan becomes challenged, there are basically three paths: there's modification, there's loan sale, there's foreclosure. Frankly, over the last 12 months, we've seen you pull all three of those colors off the palette. Walk us through the decision tree as to how you approach that. I think it's instructive.
Yeah. So typically, the first step is modification. So if a borrower is experiencing difficulty or behind in the execution of the business plan, there may be a loan modification that occurs and that, but typically, what we're gonna look for to modify a loan is, we wanna see additional financial commitment from the borrower or the sponsor, where they're gonna pay down the loan, they're gonna fund reserves, do something that's going to put more capital into the deal. And we also need to see an operating commitment or an operational commitment, where we're comfortable that they're doing everything they can do to maximize the operating performance of the asset, or in the case of a construction loan, they're hitting milestones and hitting schedules, and managing the process appropriately.
If we don't see that, then that's when we may go down a path of a loan sale or a foreclosure. Whether we sell the loan or foreclose a loan is very much gonna be a case-by-case analysis of how much capital is gonna be necessary, and what the return on that capital could be, and when i t's a, it's a multi-level analysis that we go through to figure out, how do we maximize the recovery in those scenarios?
Got it. With that in mind, you know, there's a very specific case earlier this year, and actually, having watched you in the fourth quarter foreclose on a number of properties, this quarter, you disclosed a loan that I believe moved very quickly from a four rating to a sale at a 20% discount, on a relatively large loan. We've had a lot of questions about the timeline and then the decision there. What drove that? What, what drove you in that situation to saying: "You know what? We don't wanna own the property. We just wanna take first loss, best loss, and move on"?
Yeah. And there were a lot of factors that went into that. So this was a very large construction loan on a multifamily asset in California. It was in a sub-market that we like a lot. As we started working through the potential for a modification or foreclosure, we'd actually filed to foreclose on the loan, and as we started digging into what was gonna be required to get the contractors back in place, complete the project, looking at the amount of capital that was gonna be necessary to do that, it was gonna result in a very large amount of unearning, non-earning capital on our balance sheet.
Future, significant future fundings, close to $100 million of additional dollars necessary to complete the project that the borrower was. Expectation was the borrower would do it, but they had capital difficulties due to internal issues with the borrower. We made the decision that having that level of non-earning assets was even though we were comfortable where the ultimate value of this asset would be, we didn't think it was the best use of capital for the business. So we decided to sell the loan.
We had a lot of inbound calls related to selling the loan or foreclosing on the asset and selling the asset, and we decided the best course of action was to move on from this asset, generate liquidity, de-lever the balance sheet, and eliminate a pretty large future funding obligation to complete that asset. So and that was sort of the decision tree we went down. It was not an easy decision. It was a very tough decision. There were, and it was heavily debated.
No, no doubt. So, look, it raises a really interesting issue, which is that the virtue of the mortgage REIT structure is the permanency of your capital. I think you would argue that one of the detriments is that you have to deal with folks like me. But objectively, it does create some different incentives and some different optics. And so what I'm kinda hearing you say here is, "Hey, perhaps from an NPV perspective, all other things being considered, we might have made a different decision there. But from the perspective of managing a portfolio in a public vehicle that is expected to make dividend distributions, tying up capital in that way for a long period of time in a non-income generating way doesn't make sense.
Agree. Yeah. Then that was part of the decision tree. Now, we have other assets where there may be cash flow being generated by off the asset, but where the borrower is struggling with the current rate environment, they are not allocating the appropriate level of operational commitment to the underlying asset. And in that situation, we think we may be better ultimately pursuing a foreclosure path there, converting that non-earning asset to an earning asset, and then improving the cash flow of that to get to a point where we can sell the asset and recover our—ultimately recover our UPB on the loan and then some.
Yeah. One of the things that I think is very confusing to investors, and I don't think there's a clear answer to this, is that we have seen a spectrum of behaviors in terms of how aggressive mortgage REITs have been in seeking their remedies. And oftentimes, pursuing an aggressive remedy across wider swaths of your portfolio or a portfolio is perceived to be a sign of greater distress. But it could just, in fact, be a behavioral difference, an approach difference. Do you think that, and circling back to where I started, that you guys led when we first met you, with the idea that if you didn't see good execution, you were going to exercise your remedies very quickly.
Do you think that you have continued to do that, and do you think that that does create a misperception in the market?
Yeah, I mean, we are not a loan-to-own vehicle. I mean, that's our sort of last step that we would take if we're not seeing financial and operating commitment from a borrower, and we think the way to maximize the recovery is to foreclose. So that's number one. But as part of a foreclosure process, you know, it costs money, it costs time, it costs resources, and we've gotta be fairly comfortable that we see a positive outcome if we're gonna dedicate the time capital necessary to do that. Obviously, we'd much rather see borrowers perform and pay as agreed. That's what this vehicle is designed around. But, when we have to exercise our remedies, given our operating capabilities across our platform, we're very comfortable doing so.
Excellent. Well, I am, I'm impressed. We have 2 minutes and 15 seconds left, and we are approaching the last question on my sheet, which I'm hoping is gonna be a fun one for you. So I wanna give you a little time here. You spend a lot of time speaking with analysts like myself and our clients. What do you think is what's most misunderstood by analysts about your business?
I think it's primarily our financing structures. That's one of the, one of the things where, we tend to rely a lot on repurchase agreement financing or warehouse financing to fund our loans. And I think there's a misconception in the market. They think when they hear repurchase agreement or warehouse, they think securities repo, where there's daily margin calls that have to get funded within 24-48 hours. In the loan repurchase agreement space, you have a much longer gestation period.
So we are in regular dialogue with our repurchase agreement counterparties, and if a loan is experiencing difficulties, we're escalating that. We're having a dialogue early. We'll put in place a plan to maybe de-leverage that asset over time, if necessary, but ultimately get everybody into the, a position where they're comfortable with it. T here's not an overnight shock to liquidity in these situations. These are actively managed relationships, and, it's a very important part of our business. We take it seriously. We've got we think we have great relationships with our lending counterparties, and, we really manage that and take it seriously.
Terrific. Well, we are about at time. I will just say that I appreciate you inviting me to do this with you. I think what I hope comes through is the thoughtfulness. We've known the team at Claros for a long time. There are a lot of folks who don't necessarily love getting my questions. I find I get shuffled to the back of Q&A a lot of times, and so I was delighted and not actually surprised when Mike called and asked me to do this. It really does speak to the transparency and your willingness to really address the tough questions. So thank you.
Thank you, Rick.