Franklin BSP Realty Trust, Inc. — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Unaudited. The company is an externally managed REIT focused primarily on originating and managing commercial real estate debt. It also operates a conduit lending business, owns real estate, and was selling down residential mortgage-backed securities acquired in the 2021 Capstead acquisition.
Key financial results
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Interest income | $70.2 million | $49.0 million | $145.5 million | $91.2 million |
| Interest expense | $32.8 million | $12.6 million | $55.3 million | $24.0 million |
| Net interest income | $37.4 million | $36.3 million | $90.2 million | $67.2 million |
| Total income, including real estate owned revenue | $39.7 million | $37.1 million | $94.8 million | $68.6 million |
| Net income (loss) | $(25.7) million | $30.0 million | $(48.2) million | $60.2 million |
| Net income (loss) attributable to common stock | $(32.7) million | $23.0 million | $(76.2) million | $46.4 million |
| Basic and diluted EPS | $(0.43) | $0.52 | $(1.27) | $1.05 |
Q2 annualized net interest spread was 1.9%, down from 4.0% a year earlier; six-month spread was 2.3%, down from 3.8%. Average leverage was 77.1% in Q2 and 82.1% for the six-month period, compared with 75.9% and 74.0%, respectively, in 2021.
The company reported Q2 distributable earnings, a non-GAAP measure, of $30.7 million, or $0.29 per fully converted share, and run-rate distributable earnings of $24.8 million, or $0.22 per fully converted share. These measures should not be treated as substitutes for GAAP results.
Balance sheet, cash flow and capital
- At June 30, 2022, total assets were $6.26 billion, down from $9.47 billion at December 31, 2021. Cash and cash equivalents were $445.8 million, plus $11.4 million of restricted cash.
- Commercial mortgage loans held for investment, net of credit-loss allowance, were $5.18 billion, up from $4.21 billion at year-end. The portfolio comprised 174 loans; multifamily represented 74.7% of par value.
- Real estate securities fell to $270.4 million from $4.57 billion as the company sold down the Capstead-acquired ARM securities portfolio. Stockholders’ equity was $1.59 billion. Book value per common share was $15.75, versus $16.75 at year-end; fully converted book value was $15.81 versus $17.25.
- Reported debt included $3.20 billion of collateralized loan obligations (CLOs), $832.0 million of commercial mortgage loan repurchase agreements, $293.3 million of securities repurchase agreements, $98.6 million of unsecured debt, and other financing. Total liabilities were $4.57 billion.
- For the six months, operating cash flow was negative $24.0 million, investing cash flow was positive $3.40 billion, and financing cash flow was negative $3.08 billion. Cash, cash equivalents and restricted cash increased by $289.0 million to $457.2 million. Investing inflows included $3.73 billion from securities sales or repayments; financing outflows included substantial repayments of securities repurchase agreements.
- Unfunded loan commitments totaled $514.0 million. Management stated that it expects debt and equity financing and operating cash flows to be adequate for anticipated capital needs, and that the board currently intends to operate at leverage of one to three times book equity.
Material changes and unusual items
- Interest income rose with a larger commercial loan portfolio and, for the six-month comparison, the acquired securities portfolio. Higher funding costs and leverage contributed to materially higher interest expense and compressed net interest spread.
- Trading losses on ARM Agency Securities were $22.5 million in Q2 and $111.0 million for the six months. The six-month loss included $36.9 million from sales, $62.2 million from fair-value changes and $11.9 million from mortgage prepayments.
- Credit-loss provision was $32.5 million in Q2, compared with a $1.5 million benefit a year earlier. The June 2022 allowance was $47.0 million, including a $28.4 million specific reserve on a retail-property loan and higher general reserves reflecting a more pessimistic economic outlook.
- Professional fees increased to $8.7 million in Q2 and $15.4 million for the six months, principally due to legal costs related to asset recovery. The company also recorded a $5.2 million non-cash charge after calling a CLO in May.
- On April 19, 2022, 39.7 million Series F preferred shares converted one-for-one into common shares, increasing common shares outstanding. Series D preferred shares were exchanged for Series H preferred shares; the filing identifies January 19, 2023 as the Series H mandatory conversion date, subject to holder acceleration rights. Series C preferred shares are scheduled to convert in October 2022, subject to the company’s acceleration right.
Outlook, risks and contingencies
- No quantified earnings or full-year financial guidance is provided. Management said it intends to reinvest proceeds from the Capstead-acquired ARM securities into other business segments and does not intend to continue investing in ARM Agency Securities or RMBS generally.
- A significant event concerns a $113.2 million loan originated in April 2022, secured by 24 Walgreens net-leased properties. The company said the borrower provided falsified documents that materially overstated lease rents and maturities. It recorded a $28.4 million specific credit-loss allowance, placed the loan on cost-recovery status, and filed suit on July 26, 2022. A temporary restraining order freezing specified assets was issued July 27. Recovery and ultimate loss remain uncertain.
- Two loans totaling $167.7 million were classified as non-performing at quarter-end: the retail loan above and a $57.1 million hotel loan in New York City, which has been on non-accrual since 2019.
- Repo lenders may require additional collateral or repayment if collateral values decline; failure to meet margin calls could create liquidity pressure. The company also faces refinancing and renewal risk because repo counterparties are not required to renew facilities. Two facilities matured in September and October 2022; subsequent to quarter-end, the company extended and increased the Credit Suisse facility and increased the JPMorgan commitment.
- Interest-rate, credit, real estate-market, inflation and economic conditions may affect asset values, funding costs, credit losses and distributions. Management’s sensitivity analysis estimated that, with the balance sheet held constant and no management action, a 100-basis-point rate increase would raise interest income net of expense by 6.14%, while a 25-basis-point decrease would reduce it by 1.31%.
- The common quarterly dividend was $0.355 per share. The board may change or suspend distributions; preferred dividends have priority under their terms. The company reported no material change to the risk factors in its 2021 Form 10-K and no material litigation outside ordinary-course matters apart from the loan-fraud proceeding.
Important facts for investors to verify
- Developments in the Walgreens collateral-loan lawsuit, asset-freeze proceedings, and potential recovery compared with the recorded $28.4 million reserve.
- Subsequent credit performance, non-accrual status and reserve adequacy for both non-performing loans, and the portfolio’s broader credit trends.
- Whether securities-sale proceeds are reinvested as planned, and the effect of remaining ARM securities and market movements on earnings and capital.
- Repo facility extensions, collateral requirements, refinancing access, CLO funding costs and exposure to margin calls as interest rates and collateral values change.
- Conversion timing and dilution from Series C and Series H preferred stock, and the sustainability of common and preferred distributions relative to GAAP earnings and distributable earnings.