Good morning, and thank you for joining the Lument Finance Trust Third Quarter 2022 Earnings Call. Today's call is being recorded, and will be available via webcast on the company's website. I would now like to turn the call over to Charles Duddy with Investor Relations at Lument Investment Management. Please go ahead..

Thank you, and good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust's third quarter 2022 financial results. With me on the call today are James Flynn, CEO; Michael Larsen, President; and James Briggs, CFO.

On Tuesday, we filed our 10-Q with the SEC and issued a press release, which provided details on our quarterly results. We also provided a supplemental earnings presentation which can be found on our website.

Before handing the call over to Jim, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

When used in this conference, words such as outlook, evaluate, indicate, believes, will, anticipates, expects, intends, and other similar expressions are intended to identify forward-looking statements.

Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

These risks and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Form 8-K, 10-Q, and 10-K, and in particular, the Risk Factors section of our Form 10-K. It is not possible to predict or identify all such risks.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements. Furthermore, certain non-GAAP financial measures will be discussed on this conference call.

The presentation of this information is not intended to be considered in isolation, nor as a substitute to the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

I will now turn the call over to James Flynn. Please go ahead..

Thank you, Charlie. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the third quarter of 2022. Thank you for joining. I'd like to begin by addressing the current economic environment.

Multifamily market has experienced a period of transition over the last few quarters as lenders and investors react to inflationary pressures, geopolitical risk, capital markets volatility, and higher interest rates.

CRE investment activity in the market has declined as asset buyers and sellers work towards reassessing financing costs and finding a new normal for levels of asset valuations and financing structures.

Despite recessionary indicators increasing, the strong employment market remains supportive of continued rent growth for multifamily assets, although at a slower pace than we have seen over the previous two years.

That being said, we continue to expect rents to outpace expenses and believe the credit quality of the middle-market workforce housing asset class remains extremely attractive.

While capital markets and rates remain challenging, the credit profile of the middle market housing market continues to be supported by favorable supply-demand dynamics demographics, and long-term rent growth trends. In our view remaining an attractive investment and opportunity for shareholders over the long term.

Our multifamily investment portfolio has performed well. And while we did book an unrealized loss reserve against our sole office loan this quarter, which we'll discuss in more detail later during the call, the remainder of our book continues to demonstrate strong performance.

More specifically, within the bridge lending market, lending standards have tightened and pricing on new loans have increased industry-wide over the last few quarters. Our manager has being more selective with regards to credit and the average asset as appraised LTV on new loans being offered by our manager has decreased.

Our manager is currently quoting new transactions at spreads well above 4%, whereas a year ago, we were seeing loans priced with spreads in the low to mid-3%s or lower. We would expect that the average spread on LFT's investment portfolio will continue to increase as the portfolio grows.

With this backdrop, the broader capital markets have remained volatile and dislocated. Additions in the CRE CLO market remain extremely challenging and the market for new issuance is limited at this time. The last new issue CRE CLO to price in the market was in early October with AAA spreads widening to SOFR plus 375.

That's for us, AAA spread of LIBOR plus 117% on LFT's existing CLO. Liquidity for the lower rated BBB bonds remains extremely limited, effectively reducing issuer advance rates.

In order to continue our portfolio of growth on a leverage basis and fully deploy the capital we raised in Q1, we remain actively focused on executing a loan financing transaction to leverage newly originated loans from our manager.

We have historically utilized the CRE CLO market to finance our investments and continue to believe that long-term that market provides an attractive financing source due to favorable leverage as well as non-recourse non-mark-to-market features.

However, due to the dislocation just discussed, we have elected to continue the delay of our next CRE CLO financing effort. We are prepared to execute a CLO quickly to the extent market conditions improve and we are also actively exploring alternative financing options, including note-on-note financing, A note structures and the Freddie Q program.

Overall, it is clear that the cost of liabilities has increased and the market spreads on assets are also increasing. We believe it likely that newly originated assets going forward will have wider spreads than existing assets, in line with the increases in cost of financing.

We have also seen increase in short-term interest, which over time will be a benefit to LFT. With regards to our dividend, we have previously declared a quarterly common dividend of $0.06 per share for the first three quarters of 2022. This level reflected resetting of our dividend, taking into account our Q1 capital raise and increased share count.

In addition, this dividend reflected the anticipated drag on net income to common shareholders as we work to deploy the newly raised capital on a leverage basis.

We would expect our earnings to continue to be pressured in the current environment until such time as the capital markets normalize and we were able to execute an attractive loan financing transaction. In the meantime, we continue to focus on deploying our capital into commercial real estate debt investments with a focus on multifamily assets.

Our manager is one of the nation's largest capital providers in the multifamily and seniors housing space, executing over $17 billion in total transaction volume last year and servicing a $50 billion portfolio and employing over 600 employees in 30 offices nationwide.

We believe that scale and expertise of this broad platform will continue to benefit the investors of LFT. With that, I'd like to turn the call over to Jim Briggs, who will provide details on our financial results.

Jim?.

Thank you, Jim and good morning everyone. On Tuesday evening, we filed our quarterly report on Form 10-Q and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. Supplemental investor presentation has been uploaded to the webcast as well for your reference.

On pages four through eight of the presentation, you will find key updates in our earnings summary for the quarter. For the third quarter of 2022, we reported net income to common stockholders of approximately $315,000 or $0.01 per share. We also reported distributable earnings of approximately $1.7 million or $0.03 per share of common stock.

This compares to distributable earnings of $2.2 million or $0.04 per share in the prior quarter. There are a few items, I'd like to highlight with regards to our Q3 P&L. Beginning with net interest income, our Q3 net interest income was $5.5 million compared to $6.4 million in Q2 of 2022.

Excluding the impact of exit and prepayment fees on loan payoffs, which were included in net interest income in our P&L, our interest income increased during the quarter by approximately $3.3 million, from $11.2 million in Q2 to $14.5 million in Q3.

CLO interest expense increased by approximately $3 million from $4.7 million to $7.7 million, increasing net interest income by approximately $240,000. This increase was driven by rising LIBOR and SOFR rates, which were a tailwind for us.

We did however experience a reduced level of loan payoffs during the quarter, which caused the reduction in exit fees and prepayment penalties earned relative to Q2. During Q3, we experienced $35 million of loan payoffs, which generated $291,000 of exit fees.

This represents a 14% annual payoff rate, which is a significant decrease relative to historical norms. In the prior quarter, we experienced $81 million of payoffs, which generated $691,000 of exit fees and $775,000 of prepayment penalties.

For context, the total UPB of our payoffs during calendar year 2021 was $528 million or an average of $132 million per quarter. We expect to continue experiencing reduced payoff speeds over the coming quarters due to persistent interest rate volatility and economic uncertainty.

Primary difference between our distributable and reported net income during Q3 was a $1.5 million unrealized provision for loan loss. This quarterly provision is related to a single $10.3 million loan that is collateralized by an office property in Chicago. This loan was originated in July of 2018 and is LFT's only office property investment.

As of August 8 of this year, the loan was placed into maturity default. We entered into a forbearance agreement with the borrower extending the majority date to December of this year, to allow the borrower more time to market and sell the property.

Based on our review of the asset and the current Chicago office market conditions, an additional reserve of $1.5 million was recorded for this impaired loan in quarter ended September 30, resulting in a total allowance for loan losses on our balance sheet of $1.9 million as of September 30, again, solely related to the Chicago office loan.

Balloon [ph] is on non-accrual status as a result of the impaired loan classification. However, the borrower continues to remain current on debt service payments. The office market in general has been negatively impacted due to COVID and the Chicago office market in particular has been challenged.

The office property collateralizing our loan has experienced recent and near-term vacancies and the current Chicago office market is demonstrably soft all of which negatively impacted valuations of the collateral. The loss provision we've taken this quarter reflects all of these factors.

We are working closely with borrower to facilitate a potential asset sale during the fourth quarter and a repayment of our loan. If the borrower is unable to sell the asset by the extended December maturity date, we expect to take ownership deed in lieu with the goal of maximizing value for LFT.

The loan was purchased by LFT out of the CLO on August 2 and is currently being held on LFT's balance sheet unlevered. As Jim mentioned in his opening remarks, the remainder of our loan portfolio continues to demonstrate strong performance. And other than the provision taken this quarter on the office loan we have not taken any other loss provisions.

Given the unrealized nature of the loss provision taken on the Chicago office loan that provision is not reflected in our distributable earnings. Moving on to expenses. Our total expenses were $2.7 million during Q3, which is largely in line with prior quarter's total of $2.8 million.

As of September 30, the company's total book equity was approximately $245 million. Total common book value was approximately $185 million or $3.55 per share.

As discussed in prior quarters, I would like to remind everyone that as a smaller reporting company as defined by the SEC, we have not yet adopted ASC 2016-13 commonly referred to as CECL or Current Expected Credit Losses, which is a comprehensive GAAP amendment of how to recognize credit losses on financial instruments.

As a smaller reporting company, we are scheduled to implement CECL on January 1, 2023. Until then we continue to prepare our financial statements on an incurred loss model basis. I'll now turn the call over to Mike Larsen, who will provide details on our portfolio composition and investment activity. .

Thank you, Jim. Jim touched on the broader economic conditions, which have continued to be volatile and uncertain. These market dynamics have caused us and our manager to take a more measured approach with regard to new originations, including reducing leverage and increasing spread expectations for new investments.

Due to these conditions new acquisition activity in the market has slowed and the number of bridge opportunities that support current in-place cost of financing has declined significantly. That being said, we are continuing to evaluate new opportunities on a selective basis.

At the same time, we have seen payoff speeds slow reducing our capacity for new investments relative to previous quarters. We anticipate this trend continuing into 2023, while interest rate increases moderate and the general real estate markets reset to the new higher interest rate environment.

During this quarter, LFT acquired five new investments from an affiliate of our manager with a total principal balance of $47 million. Four of these new investments were loans on multifamily properties and one was secured by a seniors housing asset.

I should note that we have seen increased opportunities in the seniors housing space and foresee additions of this asset class to our portfolio in the near-term. As a reminder, our manager is one of the largest providers of capital to the seniors housing and healthcare space and therefore is well-positioned to source and evaluate these opportunities.

The new loans that were acquired this period were indexed to 30-day terms SOFR and had a weighted average spread of 397 basis points. This level represents a meaningful increase relative to the current portfolio weighted average spread of 335 basis points.

The new acquisitions had a weighted average index rate floor of 75 basis points, which also represents an increase relative to the portfolio average for 26 basis points.

We experienced $35 million in loan payoffs during the quarter, and at quarter end our total loan portfolio outstanding principal balance was $1.04 billion, which represents a 1% increase in portfolio size quarter-over-quarter and a 30% increase relative to third quarter of 2023.

The overall portfolio consists of 70 loans with an average loan size of $15 million providing for significant asset diversity. Portfolio at quarter end was 95% multi-family a slight increase from 92% multi-family as of year-end 2021.

Retail -- our exposure to retail and office continues to remain very low and due to our manager's strong focus on multi-family and seniors housing we continue to anticipate the majority of our new investment activity related to these asset classes. Touching on interest rates.

Our investment return profile had strong positive growth correlation with rising interest rates. We have included a rate sensitivity table on Page 11 of our supplemental earnings presentation and overall we expect LFT to meaningfully benefit from a continued rise in short-term interest rates as the Fed battles inflationary pressures.

Since quarter end the one-month term SOFR rate has increased from 3.04% to 3.8% as of today and the forward curve implies SOFR reaching over 5% by the spring. Holding all else equal every 100 basis point increase in SOFR is expected to increase our annual P&L by $2.1 million, or $0.04 per share.

We do anticipate a positive P&L impact from these factors over the coming quarters. And then finally on the financing side as of 9/30, our loan portfolio continues to be financed with one CRE CLO securitization has a weighted average spread of 143 basis points over one-month LIBOR and an advance rate of 83.375%.

The CLO has a reinvestment period running through December of 2023 that allows for principal proceeds from repayments of the assets to be reinvested in qualifying mortgage assets. We do not currently utilize repo or warehouse facility financing in LFT, and therefore, are not subject to margin calls on any of our assets from repo or warehouse lenders.

With that, I'll pass the call back to Jim. .

Thank you, Mike. We look forward to updating you all on continued progress during this volatile market. With that, I would like to ask the operator to open follow-up to questions..

Thank you. [Operator Instructions]. And our first question will come from Crispin Love with Piper Sandler..

Thanks. Good morning. During the quarter, the asset sensitivity didn't shine through as you might expect just given the 100% floating rate portfolio and the net exposure that you pointed out on Slide 11.

Is the key driver there the prepay fees in the quarter given the decrease, or is there anything else at play there such as a lag in how assets might reprice relative to the liabilities?.

So most of our -- I mean, our loans are floating as you point out. Most have caps in place or all caps in place of varying lengths and time. That's on the borrower side on the interest rate side. So existing assets the only impact -- the impact is with the rate change, right? The spreads are going to remain constant.

We're not disposing of assets off of our balance sheet, so there's not -- we're holding those to maturities, so there isn't any sort of pricing differential that occurs with the existing assets.

So it really is the runoff as loans payoff which I think we mentioned is -- has been slower and we anticipate it being slower in the coming quarters than what we've seen over the past couple of years. But we do see -- and the impact of that slowdown in payoffs reduces exit fees as these loans are all typically structured with exit fees.

So there is some negativity from an earnings standpoint in that we're not getting exit fees as quickly as we have in the past. But from a performance or other impact it's relatively muted. And I should point out as we ….

Okay..

…there's capital that is currently very imminently going to be deployed into new assets, but we've had some payoffs that were immediately reinvested. So there was some drag from that excess capital..

Okay. Great. Thanks. Thanks Jim. And then, Jim, you mentioned, the exit fees in the quarter? I think I missed the exact number.

It was somewhere between $300,000 and $400,000 is that, right?.

Yeah. The exit fees for the quarter Crispin were $291,000 on $35 million of payoffs..

Okay. Perfect. And then, just one last question for me, just looking at your 10-Q there was a decent move in risk ratings from the Grade two to Grade three credit bucket.

Can you speak to some of the key drivers there? And just more broadly, how do you view the credit quality in your book, especially as we're entering a recessionary environment? It seems like, it's pretty good other than that one loan that you discussed, but just curious, how that moves in credit buckets?.

Yeah. I mean, like we discussed, I mean, on the multifamily side, we feel pretty good about the portfolio as a whole. The kind of I'll call it the broad risk rating change is really reflective of the market.

And while the business plans have largely been consistent with what sponsors thought they could achieve on the rental growth side, we see inflationary pressures on the expense side. And just as you point out general, uncertainty and some recessionary trends overall.

So we think that just from a -- if you were to kind of just put a broad risk rating on the market that has changed. If you think about the asset class in our portfolio, we feel comfortable in the performance.

But with this increase in rates and inflation pressures among all the other things that we've talked about, we just feel that from a prudent standpoint and looking at it that there's greater risk today than there was three quarters ago or four quarters ago. And that's really reflective in the ratings.

And what we haven't seen in the capital markets and overall and I think until we do, we'll have some open questions is really the decrease in volatility, right? So each week each month we've been waiting for not so much that rates have to go down, or spreads have to go down, although, that could be a positive. It's the volatility.

And because of that, that's really the primary driver of those ratings. With higher rates, exits on loans are tighter than they were with lower rates and that part of it is really just the math function.

But there's relatively good sponsors and good capital ahead of good equity in our portfolio and we think it's performing well on a relative basis certainly to other asset classes and to our peers..

Thanks. And that all makes sense to me and I appreciate you taking my questions..

Thank you, Crispin..

And our next question will come from Christopher Nolan with Ladenburg Thalmann. And again Christopher Nolan your line is open. Please go ahead..

Can you hear me now?.

We can. Thank you..

Yes. Hi, Chris..

Hi.

For the CLO financing, is there any reset or changes in the advance rates that would happen over time, or is it stable once it's set?.

Yeah, there is no change to advance rates of the existing CLO. There's no change. There's a -- eventually after the reinvestment period as loans pay off, you have your typical structure of buying down senior bonds, but that's usually when those get called. And that's further into the future, but no change during the….

Okay. And given the prospect of -- it seems like a slower investment environment. You guys are being much more cautious.

Any possibility of doing a share buyback?.

I think we've talked about this in the past. I mean, the Board is -- and us as managers have talked about a number of different ways that we can continue to support the shareholders and the stock price through trying to increase the trading value relative to book. That's certainly one of them.

But I'll also -- one of the options, but I'll also point out one of the challenges that we face and what we've really been focused on is actually increasing our flow and increasing the shareholder base. And while that has positive impacts on -- as you described, it also has other impacts.

And so it's something that certainly we've talked about, but not anything that we've made a decision or expecting at any time in the near future..

Okay. Thank you..

And our next question will come from Jason Stewart with JonesTrading..

Hey guys. This is Matthew on for Jason this morning.

Are you guys talking at all about preferred share buyback?.

We have not looked at the -- currently, I think we've said in -- if you look at the -- where that rates are today, it's sub 8% cost of capital. So it would be challenging to replace it with something cheaper today.

I think the prior question on the common is probably if you were just looking at the cost of each and no other factors I think common would be more bang for your buck than the preferred..

Got you.

And then could you talk a little bit more about the lag in pricing of loan source liabilities?.

Yes. I mean look liabilities changed. The spreads are set, but rates changed immediately, right? So every time there's a change in rates, that impacts both the asset side and the liability side.

But on the spread side, the portfolio is seasoned and so spreads on loans have generally moved, a bit slower over the past -- really regular way, but also in this environment. So in order for us to replace the whole portfolio at current spreads, you need the whole portfolio to roll off.

It's really just a matter of rates change immediately, and the portfolio can only change as you have repayments. And given the anticipated slower repayment rate in the coming quarters, that will further kind of exacerbate that transition. .

Got you. Thanks.

And then could you provide, a view on where you think the terminal Fed funds rate tops at?.

I think if we have this call at a different week or month over the past three or four, I'd probably have a different answer. But the signs of somewhere around 5% in the short-term, meaning next year, seem to be -- seems to be the current goal and what the expectation is. That seems logical to me and that's kind of what we're assuming.

Whether it creeps down a little bit from there, I think depends on a lot of other factors including, just the general state of the economy, what we see in the inflation numbers, as the tightening that's gone on over the past couple of quarters actually, makes its way all the way into the numbers. I think ,we'll have an impact on where that ends up.

But I do think we're going to hit 5%, but I think it's very possible that it comes back a little bit into the 4s, and probably stays around there for at least the next four, five, six quarters. Again, I think it's heavily dependent on the data that comes in around inflation and some of the other economic indicators.

And mostly, the economists and the predictions have been wrong, in what those numbers are going to show over the past several readings.

So, I think we need to see -- I think we need to see the numbers come in somewhere where they're expected, on a -- over a couple of periods and then we can feel comfortable that the projections, even only a few quarters out on rates are more accurate than they have been over the last few quarters. .

Got you. Thanks for taking the questions..

And our next question will come from Stephen Laws with Raymond James. Again, Stephen Laws, your line is open. Please go ahead with your questions. Again, Stephen Laws your line is open. Please proceed with your questions. [Operator Instructions] And our next question will come from Matthew Howlett with B. Riley..

Thanks. Good morning, everybody.

Sort of two part question first on outlook for dividend coverage with core distributable EPS, and do you think you still can achieve that? And on that part when you look at the financing alternatives that you outlined the three sort of buckets, what can we sort of -- we look at what kind of incremental portfolio growth do you think you could achieve if you're successful ROEs those things?.

Sure. On the latter, it certainly is a question of trading. And so the first thing is our transaction is getting -- going to get done and then what is the leverage point. I think the leverage point will be perhaps a bit lower than what we've seen in the past and you mentioned how BBBs have been really pressured.

It's hard to say whether that's a -- I wouldn't think that's a long-term permanent financing change in the market. But right now, I would expect leverage to be not in the low-80s, but probably somewhere in the 70s if you were to get this transaction done.

But that would -- that could still -- if we levered call it $100 million of capital, you're still -- that's call it $400 to $450 million of assets at the lower-end. I think the returns on those again it's -- there's a reason why we've waited.

We think that using or having unlevered loans and waiting for some stability in the capital markets has made more sense so we would still look to see for -- look to execute a transaction with kind of a double-digit gross return.

And in terms of which of those -- all of those options including the -- we do have reasonable confidence that the CLO market returns at some point in the future. The question is, is that in Q1, Q2, Q3? We think it's an attractive financing source that generally had good support from the investor base.

I think it's -- I don't think it's being treated -- I don't think CLOs are being treated in a different way than other securitized products. I think it's just a general slowdown in the overall capital markets activity. In terms of.

Just so, I hear you correctly.

If you leverage $100 million just something like a 10% growth, are you implying something that the earnings accretion could be something like $0.04, $0.05 a quarter from a transaction a successful transaction?.

So let me just think about the $0.04 or $0.05. I think the way to look at it is we can lever that $100 million. If you do the math, we think yes, we can get a high-single or double-digit return on that $100 million versus unlevered return of call it 8%.

And if we can get double-digit you can run the math and say okay that's what the impact is to the shareholders.

I want to put out specific guidance on EPS because obviously that's dependent on us being able to execute the transaction, which -- while we believe we'll be able to execute the transaction the timing of which is a bit unknown at this point.

But I think it's $100 million to lever to $300 million to $400 million at a double-digit yield versus unlevered loans at – SOFR plus $350 million to $450 million. .

Got you. No we can do the math and it's compelling that's why, sort of, it goes to my next question in terms of the dividend coverage. I mean, you get -- with the sensitivities you pointed out you could pick up $0.04 or $0.08 on the interest. And then with the capital deployment I mean it seems like there's minus type of dividend coverage.

I mean were we thinking of that the wrong way?.

No. I think -- look I think that we're certainly looking and continuing to look at the earnings quality and earnings growth.

I think if you look at SOFR that's had a set aside the impact on the asset -- the asset level from an earnings level that's had a meaningful and will continue to have a meaningful impact on our bottom-line and our ability to cover our dividend as we move forward.

So that's -- again cleansing out any impact that it has on the overall economic environment assuming that things remain reasonably stable in multifamily that higher SOFR is positive to the earnings and our ability to cover our dividend from a core standpoint.

And if we can execute a capital markets transaction that adds a little bit more I think that's even better obviously. .

And just last one for me. Senior housing, I mean, just in terms of senior housing versus multifamily, you still feel that that asset class is as solid as what you see in the multis -- and you've done in multifamily? Thank you for taking my questions..

Yes, sure. I mean seniors housing again we have -- we're one of the largest seniors lenders in the country on -- at the manager level. What we've seen is high-quality assets on the seniors side.

They're looking to truly transition to permanent financing typically or often in the FHA space and they have kind of long lead times and a little bit of a longer story, but strong sponsors, acquiring assets and building their portfolios and attractive leverage points and frankly good spreads.

I mean we just see the opportunity there being pretty solid. Obviously, we love multifamily. The market in terms of bridge lending and growing rents and the rehab nature of our, kind of, existing portfolio in the last couple of years is changing. It's not gone away, it's just in the midst of a change.

And there are fewer attractive investments from our standpoint than there were a year ago and that's just a fact. And so as we've identified new assets it's not that we're not looking at multifamily. We certainly are.

But I think that we've -- from our standpoint, we've seen more attractive investments on the seniors housing side than we've seen over the past couple of years. And we think that that provides a benefit to the LFT shareholders. .

Thank you..

And at this time there are no further questions. I'll turn the conference back over to you. .

Okay, great. Thank you everyone for joining. We look forward to speaking to you next quarter. And hopefully, we'll have some stability in the market so we'll talk then. Thanks a lot. .

Thank you. And that does conclude today's conference. We do thank you for your participation. Have an excellent day..