Franklin BSP Realty Trust, Inc. quarterly report, Q3 FY2016

Business context and reporting period

Realty Finance Trust, Inc. (the issuer named in this 2016 filing; the request metadata identifies Franklin BSP Realty Trust) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The externally managed REIT originates and invests in commercial real estate loans and securities. On September 29, it replaced its former advisor with Benefit Street Partners.

Unless otherwise noted, financial amounts below are in U.S. dollars in millions. The filing reports balance-sheet comparisons with December 31, 2015, and operating results against the comparable 2015 periods.

Financial and operating performance

• At September 30, assets were $1,249.4, including $1,119.3 of net commercial mortgage loans, $57.6 of real estate securities, and $60.9 of cash and cash equivalents. Liabilities were $614.1 and stockholders’ equity was $635.3.
• Interest-bearing debt comprised $287.5 of collateralized loan obligations (CLOs), $241.9 of loan repurchase agreements, and $72.7 of securities repurchase agreements. Restricted cash was an additional $5.0.
• For the nine months, operating cash flow was $27.6, investing cash flow was $78.8, and financing cash flow was negative $60.3. Cash and cash equivalents increased $46.1 to $60.9.
• The portfolio included 73 loans and 7 CMBS positions. Loan principal value was $1,128.6; the weighted-average loan coupon was 6.1%, and weighted-average life was 2.08 years. The loan-loss allowance was $1.6. Management reported no past-due, non-accrual, or impaired loans; the weighted-average loan risk rating was 2.1 versus 2.0 at year-end 2015.
• Common distributions declared for the first nine months totaled $49.1, comprising $30.0 cash and $19.1 reinvested through the DRIP. The distribution coverage schedule attributed 56.2% to operating cash flow and 38.9% to DRIP shares; the balance came from available cash. The annualized distribution rate remained $2.0625 per share.

Material changes versus comparable periods

• Nine-month net income rose 45% to $23.7, while Q3 net income fell 28% to $5.4. Q3 net interest income was nearly flat despite higher interest income, as interest expense increased substantially.
• Management attributed higher interest income to portfolio growth, partly offset by lower asset yields as the portfolio shifted toward lower-yielding senior loans. Average leverage rose to 52.4% in Q3 from 43.0% a year earlier; the quarterly net interest spread contracted to 2.0% from 3.4%.
• Nine-month interest expense increased $9.6, reflecting higher average borrowings, the CLO, and repo-facility extension fees. Operating expenses rose to $17.9 from $13.8 for the nine months, including $3.8 of administrative services expense and higher asset-management fees; acquisition fees declined to $0.6 from $6.0.
• The company sold securities and reduced CMBS fair value holdings to $57.6 from $130.8 at year-end. It recorded a $1.0 realized loss on securities sales in 2016. Unrealized CMBS losses were $2.2 at September 30, compared with $2.3 at year-end.
• Share count increased to 31.6 million from 31.4 million at year-end. Nine-month distributions exceeded GAAP net income; the filing indicates that a material portion was funded by DRIP shares rather than cash.

Outlook, management commentary, risks and unusual items

• Management said it believed liquidity was adequate for investments, expenses, debt service, and cash distributions, but expected new investment activity to be significantly lower after the public offering ended unless additional equity is raised. No quantified earnings or investment guidance was provided.
• After quarter-end, the JPMorgan loan repo facility limit was increased from $150 million to $300 million; proceeds were used to repay and terminate the Barclays facility. At September 30, the company reported compliance with debt covenants. Repo lenders may demand additional collateral if collateral values decline, creating potential liquidity pressure. CMBS repurchase agreements were short-term, generally maturing in 30–90 days.
• The Board approved an estimated September 30 NAV of $20.05 per share on November 10, based on appraisals by Duff & Phelps and the Advisor’s calculation. The DRIP price was changed to NAV. The share repurchase program is limited by funding and annual caps; 208,470 valid requests from the January–June 2016 period were not fulfilled.
• The company reversed a previously recorded $1.3 million subordinated performance fee after concluding its payment conditions were not met. A former-advisor transition and new management appointments occurred near quarter-end; transitional financial-reporting services were arranged.
• A dismissed shareholder lawsuit left an unresolved request for $0.75 million of attorneys’ fees and expenses. The company intended to oppose the request and recorded no accrual, stating a material judgment was not probable.
• Interest-rate risk is material: 65 portfolio investments were variable-rate and borrowings were also LIBOR-based. The company had no hedges during the reported periods. A 100-basis-point rate increase was estimated to raise net interest income by 8.06%; a 25-basis-point decrease was estimated to reduce it by 2.02%, assuming the balance sheet remained unchanged.

Important facts for investors to verify

1. Confirm the issuer identity and the effect of the advisor change on operations, fees, reporting processes, and investment activity.
2. Assess the sustainability of the distribution: cash distributions exceeded operating cash flow in the nine-month coverage schedule, with DRIP shares providing 38.9% of total distribution funding.
3. Review refinancing and collateral risks, including the post-quarter JPM facility amendment, the termination of Barclays financing, and potential margin calls.
4. Monitor loan credit quality and reserve adequacy, especially given the increase in the allowance to $1.6 million and the weighted-average risk-rating change to 2.1.
5. Evaluate the basis and uncertainty of the $20.05 estimated NAV, the securities valuation, and the limits and pending requests under the share repurchase program.
6. Track the unresolved attorneys’ fee request and any subsequent resolution or financial-statement impact.