Welcome to today's Claros Mortgage Trust Q2 2022 earnings conference call. My name is Candice, and I will be your operator for today's conference. All participants will be on listen-only mode. After the speaker's remarks, there will be a question-and-answer period. All lines will be muted during this presentation portion of the call, with an opportunity for question and answer at the end. If you'd like to ask a question, please press Star followed by one on your telephone keypad. I would now like to hand the call over to Anh Huynh, Vice President of Investor Relations for the Claros Mortgage Trust. Please proceed.
Thank you. I'm joined this morning by Richard Mack, Chief Executive Officer and Chairman of Claros Mortgage Trust, J. Michael McGillis, President and Director of Claros Mortgage Trust, and Jai Agarwal, CMTG's Chief Financial Officer. We also have Kevin Cullinan, Executive Vice President, who leads MRECS Originations, and Priyanka Garg, Executive Vice President, who leads MRECS Portfolio and Asset Management. Prior to this call, we distributed CMTG's earnings supplement. We encourage you to reference these documents in conjunction with the information presented on today's call.
If you have any questions following today's call, please contact me. I'd like to remind everyone that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our other filings with the SEC.
Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will also be referring to certain non-GAAP financial measures on today's call, such as distributable earnings, which we believe may be important to investors to assess our operating performance. For non-GAAP reconciliation, please refer to the earnings supplement. I would now like to turn the call over to Richard.
Good morning, and thank you everyone for joining us for CMTG's Q2 earnings call. CMTG delivered another strong quarter as we continue to gain momentum across our strategic priorities in originations, asset management, and capital markets activity. During the Q2 , we originated approximately $1 billion of new loans, reflecting our continued focus on the residential sector and high-growth markets such as Dallas and Atlanta. Our asset management team also made significant progress during the quarter. As noted on our last call, we successfully resolved our largest non-accrual loan, driving a positive outcome for our stockholders and significantly reducing non-accrual loans to approximately 2% of the portfolio. We continue to make progress towards future resolution of these remaining non-accruals.
I'm also happy to report that despite the choppiness in the capital markets, we further enhanced our financing capabilities by securing an additional $150 million bridge acquisition facility. As I look to the broader markets, heightened market uncertainty has become the prevailing theme challenging investors across asset classes. Record inflation levels, disrupted supply chains, tightening monetary policy, and geopolitical challenges had until recently dominated headlines. Mixed economic data is part of the analysis. Considerations include sectors of slowing economic growth, areas of rapid inflation, areas of minor inflation, higher borrowing costs, weakening corporate margins, a strengthening dollar, declining or volatile commodity prices, and inconsistent corporate commentary.
These are conflicting signals, and they cloud the economic picture and further complicate the narrative for potential economic outcomes. It's no surprise that there's still much debate about whether the Fed can engineer a soft landing.
Here at CMTG, we think a modest recession is the likely outcome, but it's far from a certain one. What is certain is that the discussion continues to evolve and broaden in scope and complexity as we further contemplate the interconnectedness of the U.S. economy and other major economies, and what that means for our economic outlook here in the U.S. and in real estate more specifically.
On a positive note, transitional real estate lending continues to be a bright spot in today's investing environment as the opportunity set for alternative lenders has become increasingly attractive, particularly for floating rate strategies like the one that CMTG employs. Over the past several months, we have observed credit spreads widen dramatically as banks in the securitization market reduce their appetite for risk. On top of this, interest rates are also increasing at a record pace.
This has set up our new originations for potentially better total returns for the same amount or less risk than what was possible just six months earlier. Further, it seems that recent rate hikes and potential future increases will continue to provide tailwinds to our sector and greater returns. Longer term, however, we could see some credit spread tightening as absolute returns continue to climb to a place where we believe capital flows will be diverted into our sector. Amidst this positive environment for transitional real estate lending, it is important to acknowledge that rising benchmark rates and widening credit spreads are creating uncertainty surrounding equity valuations, which we believe need to adjust downward for any asset with medium to long-term leases with modest to no rent escalations or lying outside quickly inflating rental markets.
Thus, it is not surprising to note that the public equity REIT markets are already reflecting a decrease in property valuations. Given this backdrop, CMTG has been focused on lending to rental housing assets with short-term leases and high growth undersupplied markets, where cash flows are likely to increase more rapidly. When real estate values are uncertain and assets with stable cash flow may be devaluing, we believe that CMTG's strategy of participating in the capital stack as a debt provider, specifically at an attachment point where our position has significant subordinate capital to protect our investment, is as relevant as ever.
I believe that this is one of the best times to be a lender in the property sector that I've seen in my career. It is not just being in the right sector at the right time that allows CMTG the opportunity to succeed.
It is the institutional nature of our platform. Its established investment processes and procedures, combined with the multigenerational and multicyclical experience that the Mack Real Estate Group has as an owner, operator, manager, and developer. We believe these factors will continue to be the essential drivers of our performance. Our investment strategy focuses on transitional lending opportunities secured by high-quality assets backed by institutional-grade sponsors. We originate primarily floating-rate senior loans at compelling LTVs, targeting major markets and select high-growth markets. As one of the largest commercial mortgage REITs, we have the scale to provide lending solutions to some of the most well-capitalized real estate sponsors in the world. In addition, our reputation and experience have enabled us to develop trusted and durable financing relationships as we have scaled our business.
We believe that the access to liquidity enabled by these relationships will become increasingly important as certain financing counterparties become more conservative or even choose to sit on the sidelines. Our recent $150 million bridge acquisition facility closing amid the capital markets turmoil demonstrates our ability to access incremental capital during a period of stress and speaks to the strength of CMTG's credit quality and our capital markets team. As we look ahead, it's the sum of these parts that we believe will drive our success. Experience, capabilities, relationships, access to capital, the strength of our balance sheet, its low leverage, and access to financing. We are fortunate that prudence has allowed us to carry a higher cash balance at a time when spreads and rates are increasingly lender-friendly.
Therefore, we believe we are well positioned right now to be highly selective and opportunistic in this dynamic market as opportunities continue to unfold. I would now like to turn the call over to Mike McGillis to discuss the portfolio.
Thank you, Richard. We have been migrating our portfolio to asset classes that we view as defensive in nature and to sectors exhibiting strong underlying supply-demand fundamentals to support continued revenue growth at the asset level. In addition, we continue to deploy capital to select high-growth markets demonstrating favorable demographic trends and job and wage growth. Our Q2 originations activity reflects our continued focus on these high conviction themes. During the Q2 , we originated approximately $1 billion in total loan commitments across eight investments, bringing year-to-date 2022 originations to $2.2 billion. Approximately half of our Q2 originations were in the multifamily sector, which resulted in a 9% increase quarter-over-quarter in our multifamily exposure.
In addition, we continued to add build to rent and industrial investments to the portfolio while capitalizing on attractive opportunities that we sourced in the hospitality and mixed-use sectors. Multifamily continues to represent our largest property type, comprising 41% of the portfolio's UPB at June thirtieth, and we expect multifamily to continue to be an overweight allocation for us. For example, we originated a $152 million floating rate loan collateralized by a portfolio of multifamily assets in Dallas, Texas. The borrower here is well known for its extensive value-add experience and significant presence in this market. The business plan is responsive to the demand for renovated multifamily product in a desirable submarket of Dallas that has demonstrated strong double-digit rent growth and low vacancy rates. Our portfolio UPB has remained relatively unchanged quarter-over-quarter at $7.1 billion.
Initial and follow-on fundings offset the elevated volume of repayment activity we experienced during the quarter. Of the $782 million in repayments, including the loan sale proceeds from the non-accrual loan Richard mentioned, $562 million were collateralized by assets located in New York, which contributed to the 8% quarter-over-quarter decrease in our New York exposure. The reduction in New York exposure represented a mix of property types, including hospitality, office, for sale condo, mixed use, and land. As previously mentioned, one of our priorities has been to further diversify our portfolio by geography, and we believe we've made excellent progress on that front.
As of June 30, New York represented 25% of the portfolio, compared to 44% for the same period a year ago. With the exception of California, comprising 21% of the portfolio in the D.C. Metro area, comprising 12% of the portfolio. No other state represented more than 10% of the portfolio. In addition, we've been deploying capital and increasing our presence in Texas and Georgia, which represented 10% and 8% of the portfolio, respectively, at June 30. As Richard mentioned, we successfully resolved our largest non-accrual loan during the Q2 , $116 million New York land loan. Given our ownership mindset approach towards lending, we believe we can benefit from taking a longer duration view on certain investments, given our conviction in our underwriting and the quality and basis of the underlying collateral.
This land loan provides a good example of how our investment and asset management approach enabled us to deliver an attractive outcome for our stockholders. The investment generated a levered gross return of approximately 12.5%, and we recorded a $30 million or $0.21 per share gain during the Q2 as a result of this resolution. I would now like to turn the call over to Jai.
Thank you, Mike and Richard, and good morning, everyone. For the Q2 , we reported distributable earnings excluding realized losses of $71.5 million or $0.51 per share. This compares to the prior quarter of $33.5 million or $0.24 per share. GAAP net income was $63.2 million or $0.45 per share. The quarter-over-quarter increase in distributable earnings was primarily due to, one, $0.21 per share gain resulting from the resolution of the non-accrual land loan. And two, improved operating performance of our New York City REO hotel portfolio that contributed $0.03 per share to distributable earnings compared to a loss of $0.03 per share last quarter. A swing of six cents per share.
We also recorded a charge-off of $11 and a half million or $0.08 per share against a $16 million dollar loan that is on non-accrual status. This loan is secured against the estate of a former borrower and previously had a $6 million dollar CECL reserve against the loan. This quarter, based on a proposed settlement offer, we recorded an additional $5 and a half million CECL reserve and charged the total $11 and a half million reserve as a realized loss from a GAAP standpoint. We now expect to collect $3 and a half million against this loan. Our general CECL reserve stands at $73 million or 1% of our outstanding principal balance. This is an increase of $3 million over last quarter, primarily due to portfolio growth and macroeconomic assumptions. Turning to liquidity.
We ended the quarter with over $460 million in cash and $735 million in unencumbered loan assets. We entered into a $150 million bridge acquisition facility that enables us to close loans unlevered, giving us up to 6 months to seek optimal financing. We continue to carry excess liquidity for both offense and defense. With respect to interest rates, after the recent increases in interest rates, we are now asset sensitive as we pass the crossover point where our portfolio earnings are positively correlated with increases in benchmark rates. We estimate that a 100 basis point increase in rates over spot rates at June thirtieth would result in an annual increase in net interest income from our existing portfolio by $0.12 per share. Rates have already increased and continue to rise since June thirtieth.
At quarter end, our leverage remained at 1.9 times, which is one of the lowest in the industry. We expect this to increase as we deploy additional capital and still maintain a target leverage level of 2.5-3 times. Lastly, the CMTG stock was added to the Russell family of indexes during the quarter as we continue to see an increase in daily trading volumes in our stock. I would now like to open the call to questions. Operator, please go ahead.
Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you'd like to remove your question, please press star followed by two. Again, to ask a question, it is star followed by one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking a question. Our first question comes from the line of Rick Shane of J.P. Morgan. Your line is now open. Please go ahead.
Good morning, everybody. Can you hear me?
Yes.
Excellent. Hey, Richard. I think I'm hearing in some ways two things from you, and I'd love to sort of reconcile them. In one way, I think you're saying, "Hey, the markets are dislocated. When investors are scared, it's a good time to be putting capital to work," and you position yourself well to do that. And I realize that touring can be a little bit unnerving, but I think it makes sense. At the same time, when we look and think back about what we've heard in earnings calls this quarter, the sort of consensus trade continues to be multifamily Sun Belt. How do you reconcile the idea of being contrarian with also, how crowded potentially that particular niche could be?
Well, thanks for the question, Rick Shane. I don't think there's actually a reconciliation needed. We are perhaps not being as opportunistic as we could be, because what we're able to do is invest in concessions that as a lender, but make returns in cash flowing assets that we might have previously had to make a construction loan to achieve a similar return. We are basically, because of the backup in the market, taking a pretty conservative approach as to what we're lending on and the LTV/LTC that we're lending. Because of the backup in the market, are able to achieve returns that are very similar for less risk than we were doing before. It may be that we're not being as opportunistic as we can be at all times.
We're gonna be selective about construction and alpha generating trades. We feel pretty good that we can move down in risk and make similar to better returns. That's kind of the way we've been playing the market here. I think we will continue to kind of barbell this with more conservative cash flowing Sun Belt multi, where we see the demographic demand as being very strong and we think as close to recession-proof as we see. Also with short-term leases that can take advantage of the inflating market and protect you against interest rate moves. We'll continue to do that where there's a capital shortage and be opportunistic when we really think we're getting paid to take more risk. Hopefully that was responsive.
Very responsive, very helpful and gives a lot of insight and helps me understand what's going on much better. Thank you.
Thank you.
Thank you. Our next question comes from the line of Donald Fandetti of Wells Fargo. Your line is now open. Please go ahead.
Yes. Can you talk a little bit about your expectations for net portfolio growth over the next few quarters? It looks like Q3, the portfolio may have declined a bit and kind of how this all ties into your ability to cover the dividend with core earnings.
Jai or Kevin?
It's a function of repayments, Don. , the more repayments we get, the more we can grow the portfolio. In terms of your second question about covering the dividend, we feel good about covering the dividend, especially if you look at the forward curve on SOFR, and if you look at page 16 of our deck, we are now asset sensitive, and any increases in interest rates go straight to the bottom line. Based on a combination of or in spite of slower deployment pace and slower repayment pace, we expect to cover the dividend for the full year.
In terms of net portfolio growth you shrunk a little bit this quarter, and it looks like based on what we've seen for Q3, that it declined a little bit more. Do you expect that to continue to moderate? Can you just talk a little bit about deal flow on the ground? Is there enough activity to kind of replace the repayments?
Yeah, I'll start. , we are sitting on $460 million of cash, so we are being very selective in where we are deploying. There are lots of opportunities that we are seeing, and Kevin can add more color on the market. , if repayments also will drag on, meaning outstanding loans on the ground will, if they do not pay, those loans might extend, and that will help us generate further earnings.
Sure.
This is Kevin Cullinan here. I'll chime in on sort of the opportunity set at hand. It continues to remain very robust in our perspective, and there are a lot of opportunities that we're constantly and regularly evaluating to redeploy capital as we are receiving repayments. I would go so far as to say this kind of mirrors or echoes what Richard had said earlier that we feel like we can do that at an accretive level in this spread and interest rate environment to some of the repayments that we are receiving at this point in time. We remain bullish on being able to recycle capital into accretive and perhaps even less execution risk assets.
Yeah, no. Definitely look, it's great to see the repayments, particularly given the New York, New York exposure and the history. I was just trying to get a sense if you think you can get back to a growth mode. Thanks.
Thank you. Our next question comes from the line of Jade Rahmani of Keefe, Bruyette and Woods. Your line is now open. Please go ahead.
Thank you very much. Away from multifamily in the Sun Belt, which you characterized as defensive, where are you seeing the best opportunities? Can you give any color on the types of situations?
Kevin wants-
Sure, Jade. It's Kevin. I can take that, Jade. Away from the multifamily trade, which we've obviously been very active in, we have closed on and are working on a few what we would refer to as higher end leisure-driven hospitality assets where we think there's still really good relative value. That's notwithstanding the structural protections and the underwriting that we're implementing to reflect what could be some meaningful economic uncertainty over the term of the loans that we're working on right now. That is a spot in the market that the assets are performing well. They're recovering very well coming out of the pandemic.
We see fairly consistent ADR RevPAR occupancy growth throughout 2022 and forward bookings, importantly. It's a little bit of a less crowded space in terms of our competition. We do expect to continue to look at those and evaluate those, but be very selective not only on the assets but also at the levels that we're willing to invest in in those particular capital stacks. Another one which we feel like we have a little bit of an edge on is certainly the industrial sector.
We did close an asset in the Q2 in the industrial space that heavily structured and credit enhanced by not only the borrower but a partner that has a forward takeout of that asset down the road. We're very happy with the risk-adjusted nature of that and working on some similar type investments where we're generating some alpha, meaningful credit enhancement by virtue of deposits on hand, cash on hand, as well as forward takeouts of some of those assets. I would say away from multifamily where we see some very attractive relative value if you can sort of cut through some of the noise is lease-driven hospitality and new build industrial.
On the multifamily side, with respect to defensiveness historically rents have not declined, gone negative during periods of economic softness. However, we've been in a period of extremely robust, inflation and rent growth, as well as the multifamily sector being, I would say, the darling asset class over the last 10 plus years. As you're underwriting deals, how do you account for a correction in multifamily values that I believe is underway and also moderating rent growth outlook in your underwriting? Thanks for taking the question.
No, great question, Jade, and happy to take that as well. I'd say it's twofold. We're fully expecting rent growth to at a minimum decelerate in many of the markets that we're working on and that we're looking at. We're underwriting those assets accordingly. I'd say more importantly, at the levels that we are lending at and investing at, we are going in at debt yields or cap rates to our position that we feel are protected day one and not reliant on future rent growth. , the rent growth is obviously upside and important to the equities business plan. But when we're going in at mid-single digit debt yields, perhaps there is a little bit of upside to a rent roll.
Perhaps there is some future rent growth in the market. We're trying to size our positions where we're not relying on that whatsoever and that we're at a debt yield that is supported by forward-looking cap rates with some assumptions on interest rate movements over time and where we expect the 10-year to be when we're looking at whether it's initial maturity or beyond that. We're eyes wide open to it, and we feel like we're picking our spots appropriately and not relying on that. That type of future growth, everyone can come to the conclusion that it's difficult to sustain in the long term.
Thank you.
Thank you. As a reminder, if you'd like to ask a question, please press star followed by one. Our next question comes from the line of Steve DeLaney of JMP Securities. Your line is now open. Please go ahead.
Good morning. Thanks for taking my question. Just, we're starting to hear some signs because of repricing of credit in the marketplace for comparable assets, say, today versus 6 months ago. Can you comment on that and your spreads over LIBOR that you're achieving on comparable loans, where would you say that has moved, say, in the last 6-12 months? Thank you.
Thanks, Steve. I can take that again. I would say, I'll focus on the last 6 months because in this market and in this environment, 12 months feels like a pretty distant memory at this point.
Ex-exactly.
Apples to apples risk on apples to apples asset classes and business plans. I would say over the last six months or perhaps since the end of the year, we could say, spreads are probably out a minimum of 100 basis points.
Yeah.
that unfortunately, and we should say this some of that is being driven by the bank financing market or the lack of securitizations that have become a little bit available in the market. That's not all ROE, but
We're seeing , ROE growth or net interest income on those underlying assets that is accretive to our position and accretive to the portfolio in the long term. We're definitely having to work harder on the liability side of the balance sheet to make sure that we're putting together the optimal capital stack.
Got it. Obviously, you had $1 billion come in and then $600-$700 million or so go out in new loans. I assume with the way you're describing that, Kevin, is pretty much the newer loans going out have the stronger spreads versus what paid off. On the left-hand side of the balance sheet anyway, your returns are improving, not .
That's the offset right. The whole loan.
Okay.
, definitely, going out in new investments at higher levels than repayments, generally speaking. , we're very focused on making sure that we're optimizing the capital stack.
The repricing that you're having to negotiate on your financings. Is it? Would you describe that as broad? I mean, is this sort of a market-driven thing, or is it a particular bank who's reducing, trying to tighten up their credit box? , or is it just all the banks are kind of in line on that, on the financing?
I can take that, Steve.
Thanks, Jai Agarwal.
Yeah, Steve. Just to be clear, it's repricing of credits on new financings, not existing financings.
Got it. Oh, yes.
.
Exactly.
It's a function of it varies bank by bank. Say there's one or two banks who are just not doing any new business. For the most part, banks are quoting loans just at wider spreads than they were previously. We've been in a good position. We've been in a good position to obtain financing both from our warehouse counterparties, but also from note-on-note format. We are in a good position. , there are banks. Banks have become more selective in terms of who they will lend to. I think banks are concentrating their lending platform to larger players like ourselves.
Yeah. Thank you both for your comments.
Thank you. As there are no more questions registered at this time, I would now like to turn the conference over to Richard Mack for closing remarks.
Thank you. I just wanna thank everyone for joining. In response to some of the questions, I would finish off by saying we have capital to deploy. With repayments, we'll have more. It's a really good time to be a lender. It's, I think, in many ways a tough time to be a borrower. , I think we're in an environment where we can be in growth mode and also reducing our risk in terms of the amount of cash flow assets that we're lending to and diversifying our portfolio. Particularly by lending to multifamily in high growth markets at cap rates where we don't need much rent growth at all. These are assets that follow our mantra.
They're assets that we want to own in markets where we have a lot of experience and expertise at a basis we find compelling, which is kind of the way we look at the world. We're getting spreads that previously have been associated with heavy transitional for light transitional. We really like that trade. As Kevin mentioned, we also have an ability to get industrial exposure in a way that we haven't in the past. We are gonna continue to pepper our portfolio with alpha generation in terms of continuing to exploit our capabilities around development and making some construction loans, particularly in the industrial sector. Also making loans in the hospitality sector to create alpha where we really see mispriced opportunities.
I think it's a quite an exciting time to be a lender, despite concerns around asset valuations, given the amount of subordination of capital that we're able to get, because of the backup in the capital markets. I wanna thank you all for listening and just give you a sense of how bullish we are right now about the environment. I look forward to talking to everyone again on the next quarterly call.
Ladies and gentlemen, that concludes today.